Editor’s note: This article was first published in September 2015; its references to Islamic State attacks, Syrians fleeing their country, Steven Pinker’s research described as recent and the World Cup example based on Spain’s 2010 win reflect that time.
We all believe that we make decisions based on entirely reasonable and logical thinking, but in recent years the combined findings of behavioural researchers have shown that our way of thinking is completely flawed and that we are rarely capable of making logical, reasoned decisions.
We are often victims of our own errors in processing the information our brain receives, as we saw in our article “10 findings in psychology that explain why we make bad decisions”.
These mental errors are our weakness, and at the same time they are what make us so easy to manipulate for people who make a living from exploiting them.
There are hundreds of biases, but we are going to look at some of the ones that crop up most often in our lives, and which basically tell us that “we are dumber than we think, even though we believe we are smart”.
These are eight of the best-known cognitive biases
1. Survivorship bias
If we look at the popular media and all kinds of blogs (this one included) offering advice on the guidelines and habits we should follow to succeed, we will find headlines such as “10 things successful people do”, “The best advice Richard Branson ever got for succeeding in business” or “What successful people eat for breakfast”.
Survivorship bias refers to our tendency to focus on the “winners” in a particular field.
The problem is that we ignore the “losers” who are following those very same guidelines and habits right now.
In other words, nobody focuses on the thousands of people who never succeeded; we only hear from the people who survived. As a result, we overrate the tactics and strategies of the survivors, ignoring the fact that many of those strategies are the same ones used by the people who failed.
The actions that lead you to success are the same ones that lead you to failure
Are we afraid to call it luck? Let’s call it statistics, then, because there is no room for 1,000 entrepreneurs fighting to lead the same market, just as there is no room for 1,000 applicants for a single job opening. And that job does not always go to the person best qualified to do it.
That is why, whether we take Tim Ferriss’s advice (a company is just a source of income: have a company, but find a way not to run it and spend all your time dancing, doing martial arts and sitting around doing absolutely nothing) or Michael Bloomberg’s (work harder than everyone else and don’t even go to the toilet, because while you are in there someone else is fighting to take your place), we can clearly see how two pieces of advice that completely contradict each other both work.
The two strategies are incompatible; both strategies are excellent, because they work. They are the ones used by thousands of people who failed, and the ones used by thousands of people who succeeded.
As we explained in our previous article, people forget the “base rates” Daniel Kahneman talked about, and the good news is that we can raise those rates to have more luck and more success.
What is clear is that taking action can lead you to success or to failure. Whoever takes no action at all has every chance of certain failure.
2. Outcome bias
Richard Branson, Steve Jobs, Bill Gates and Mark Zuckerberg, among others, dropped out of university and became billionaires. And it is true that you don’t need to go to university to succeed in life. In fact, look at Branson, Jobs, Gates… they made it.
By the time some of their classmates finished their degrees, these geniuses were already millionaires. The message is clear: don’t waste your time at university, and go out and chase your real dream of becoming a millionaire.
The thing is, these billionaires did not succeed in business because of their decision, but in spite of it. For every Branson and every Zuckerberg there are thousands of entrepreneurs who are broke, in debt and without a university degree to open the doors of a company to them.
In hindsight we can explain any success and any failure, but the explanations are often biased by the outcome. No observer can guarantee a successful outcome from the actions that are taken, but, to be honest, you can predict a failure foretold with high probability just by looking at the actions that are not taken.
3. Loss aversion
Loss aversion refers to our tendency to prefer avoiding losses over acquiring gains.
Our aversion to loss leads us to make foolish decisions and to change our behaviour simply to hold on to what we already have.
It is the most dangerous bias investors are exposed to, because this mental processing error is what leads investors to sell the shares that are showing a gain (locking in the profit) and hold on to the shares that are losing money (loss aversion).
Investors know that the moment they sell their shares at a loss, they will have lost money, so they cling to the idea of keeping them, waiting for the price to go back up.
According to the various studies collected by Daniel Kahneman in his book Thinking, Fast and Slow, research has shown that, as a rule, the shares investors sold to lock in gains kept rising after they were sold (the investors missed out on making more money), while the shares they kept to avoid taking a loss fell even further while they held them (they lost even more money).
This is the bias that makes it painful to throw away something you bought and have never used (and never will).
And it is certainly to blame for people not taking risks to succeed, because of everything they could lose if they don’t succeed and fail instead.
4. Availability bias
The availability heuristic is a very common error our brains make when they assume that whatever comes to mind is what is most important and most frequent.
Steven Pinker’s research has recently shown that we are currently living through one of the least violent periods in history. More people are living in peace right now than at any other time in history. Rates of homicide, rape and child abuse have fallen considerably.
Most of us think this is not the case, even though crime statistics confirm it. It is hard to believe that we are living in the most peaceful period in history when we see murders on TV every day, several open wars, Islamic State attacks and thousands of Syrians trying to escape their country and find refuge.
But the truth is that, according to the research, we are not only living in the calmest period in history but also in the best era ever recorded. Why don’t we see it that way? Because of the availability bias.
Never before in history has news of crime, rape and terrorism been as available as it is now, and that is exactly what you are bombarded with while you eat lunch. Even though there are far fewer serious incidents than in the past, they now reach you much more easily.
This could also be called “the culture of fear”, also known as “selling newspapers”.
If you feel that politicians are more corrupt now than before, it is down to better journalism rather than to growing corruption, because since the dawn of time politics has always been a refuge for corruption.
What you look for is what you will find, so if you want terrorism and rape, go online and you will get your fill of every kind of negative news. On the other hand, if you look for life expectancy, medical advances and charitable work, we are also living in the best moment in history.
There have always been wars and terrorism, yet today we remember Alexander the Great as a conqueror. Rapes and murders happened every day, but not everyone got to hear about them.
This bias also makes the most recent events seem more important to us. So if you have recently had a business failure, you will associate a new venture with failure, just as, if you have had several successes in a row, you will think your next attempt will be another success. Which brings us to another truly important bias…
5. Overconfidence bias
Someone who fails several times in a row may come to see themselves as a failure, and may even fall into learned helplessness.
But someone who has had many successes in a row is just as much at risk, because statistics will often do their work, and it becomes inevitable that this person will stumble.
Investors know this part very well. Have you ever wondered why your biggest stock market mistakes came when you had the most capital exposed to the market? Have you wondered why a single failure wiped out the profits from your other three successes? It is the overconfidence bias, or false-expert bias.
When a small investor decides to speculate in the markets, they should bear in mind that they are up against the people and organisations that literally move the market. Your gains on short-term trades are often more the product of luck than anything else, especially if you speculate on emotion rather than with a mechanical, systematic method.
That is why a monkey throwing darts to choose which stocks to invest in got a better return than most investors who used their knowledge to pick them. And it is not a joke but a real experiment. The monkey proved to be a better investor than the “expert” investors at major investment firms.
We commonly think that our good decisions are the result of how smart we are and that our bad decisions are the result of bad luck.
That is why, after a few winning trades, we forget that they are more the result of luck than anything else. We get overconfident, we think we are experts, so we expose ourselves even more to make more money, and we end up suffering our biggest loss. That is when we realise we still have a lot to learn.
And that brings us to the next problem…
6. Regression to the mean
Put simply, regression to the mean means that among competitors with equal talent and preparation, the one who today achieved results far above the average of the field (extraordinary results) will do worse next time, while the one whose results were dreadful, far below average, will do at least somewhat better next time.
Professional sports bettors know this rule. After Spain won the football World Cup, they did not know who would win the next one. But they were clear (through probability, statistics and regression to the mean) that Spain would not win it again. At least, that was not the most likely outcome.
Many small savers looking for the best fund manager forget this. They see that the average return for the fund management industry was 10% a year, but that “Company X” returned 60% last year.
If we don’t follow this rule, and you are like most people, you will most likely invest in Company X in search of that 60% return. And because that was a truly exceptional result, you will most likely find that the following year the company’s return is much lower, and that the highest return that year goes to another company that had mediocre returns the year before.
7. Confirmation bias
Even people with the highest IQs can suffer from this bias. Confirmation bias refers to our tendency to seek out and notice information that confirms our beliefs while ignoring any information that contradicts them.
Before I had studied human behaviour and biases, I used to call this “idiot thinking”. And we can see it perfectly in matters of politics and religion, the topics you should never discuss precisely because of confirmation bias.
Politician 1 vs Politician 2: A supporter of Politician 1 will ignore any information that attacks Politician 1 (and consider it false), even if that information is true. On the other hand, they will love any information that attacks Politician 2, even if it is false (they want to believe it is true).
Until you are able to confront your beliefs and apply an impartial, objective, logical and rational analysis, your opinion will always be tied to your belief, and so it will not be a valid opinion.
That is why people often say: never argue about politics or religion, because everyone believes their beliefs are logical and well founded, when the truth is that the other person’s beliefs, like yours, are probably unfounded and lack any objective analysis.
That is why the goal of our personal growth, in every sense, is to seek out and learn from information that challenges our beliefs. It is very hard to change your mind once this bias enters your life, because nobody considers that their brain is working from a flawed system: a belief deeply rooted in the mind that has never been tested against the truth, the objective and impartial truth (the real truth).
8. Commitment bias
If there is one thinking error we rarely think about, and which, if we did, would show us how foolishly it makes us behave, it is commitment bias (often called the sunk cost fallacy). Commitment bias is the tendency to use a loss (of time or money) as an excuse to increase that loss.
Suppose you pay €20 to go to the cinema with your partner, and you both think the film is crap. In cases like this, people almost always end up watching the whole film because they have already paid the €20. But by doing so, you have not only lost €20; you are also going to waste your time watching something you don’t like.
It also happens when you are eating and can’t manage another bite. Someone at the table says: “With all the children going hungry in the world, and you’re going to leave that on your plate to be thrown away.” And they are right: if instead of throwing it away you eat it without wanting it, even if it makes you feel sick afterwards, you are doing the world’s hungry children a favour.
Try to spot this bias, because it is present in many areas of life. Some couples often stay together not because of the love they feel but because of how long they have been together. It is like an investment of time they have made, and even though they are unhappy, they prefer to stay unhappy.
All the biases and research discussed here are explained in Daniel Kahneman’s book “Thinking, Fast and Slow”; the text, examples and adaptation are our own.
