Understanding Bias in Self

It starts with you

Cognitive biases are the unconscious drivers that influence our judgment and decision-making

Individuals are consistently poor in their awareness and control of their own biases

Implications for:

  • Making unbiased decisions about who to hire or promote
  • Where to allocate resources
  • What information to prioritize in decision-making



    Some examples

    In the comfort zone

    A salesperson in an investment firm spends most of his time calling on clients in his home city, because he feels he knows the area best, even though there are significantly bigger clients in other cities in his territory. He’s unaware of being biased and that it’s costing himself and his firm significant revenue.

    Finding people similar to you

    A fund manager is in the process of hiring a new employee. While reviewing resumes, she unconsciously prefers candidates of a similar age and background to those already on her team. The manager tells herself that she is working to build a cohesive team, unaware that she is biased or, as a result, that her team will make worse decisions.

    Basing new actions on past ones

    Several years ago, a senior executive in a real estate investment firm vetoed investing in a new development project. Now market conditions have changed and its clear the project would now be an amazing fit to add to the portfolio. When the project is presented again, he easily recalls the older data upon which he decided to veto the idea. Newer data, which he doesn’t know as well, clearly shows the project is now a good investment. To add to this, he has no idea that he is biased or that a business opportunity will be missed.

     

    • Understand yourself to understand your bias

    Biases are in the air all around us, invisible but exerting influence beyond our awareness. They are adaptive mechanisms evolved to help us make fast, efficient judgments and decisions with the least cognitive effort. As a result, biases can impact every decision we make.

    On the one hand, biases are helpful and adaptive. Biases help us use previous knowledge to inform new decisions, a kind of cognitive shorthand, as we do not have the cognitive resources to make every decision fresh. However, many of our biases can also be unhelpful. Biases can blind us to new information or inhibit us from considering a broad range of options when making an important decision and choosing our path carefully.

    A deeper look at positive and negative biases

    + -
    Helpful & Adaptive Unhelpful & Maladaptive
    Helps us use previous knowledge to inform new decisions Blind us to new information
    Saves time and energy Inhibit us from considering a broad range of options

    Prevalent types of biases

    So now that we more fully understand the concept of bias let’s explore the most prevalent types. So here they are:

    1. Overconfidence Bias
    2. Self Serving Bias
    3. Herd Mentality
    4. Loss Aversion
    5. Framing Cognitive Bias
    1. Narrative Fallacy
    2. Anchoring Bias
    3. Confirmation Bias
    4. Hindsight Bias
    5. Representativeness Heuristic

    Let's go deeper on each

    Overconfidence Bias

    Overconfidence results from someone’s false sense of their skill, talent, or self-belief.

    It can be a dangerous bias and is very prolific in behavioral finance and capital markets. The most common, manifestations of overconfidence, include the illusion of control, timing optimism, and the desirability effect

    Manifestations of overconfidence:

  • Illusion of control is straightforward
  • Timing optimism - occurs when people are too optimistic about how quickly they can perform a task. This can lead to critical mistakes in the work itself and the missing of deadlines when it takes longer than people estimate for themselves to complete
  • Desirability effect - the belief that something will happen because you want it to

    Watch this video for an example of overconfidence bias

    • Self Serving Bias

    Self-serving cognitive bias is the propensity to attribute positive outcomes to skill and negative outcomes to luck.

    In other words, we attribute the cause of something to whatever is in our own best interest.

    Many of us can recall times that we’ve done something and decided that if everything is going to plan, it’s due to skill, and if things go the other way, then it’s just bad luck.

    Take a moment and think about two examples in your life:

  • A positive outcome event where you attributed to skill
  • A negative outcome event where you attributed to luck

    Watch this video for an example of self serving bias

    • Herd mentality

    Herd mentality is when investors blindly copy and follow what other famous investors are doing. When they do this, they are being influenced by emotion, rather than by independent analysis. There are four main types: self-deception, heuristic simplification, emotion, and social bias.

    Self-Deception
    The concept of self-deception is a limit to the way we learn. When we mistakenly think we know more than we actually do, we tend to miss information that we need to make an informed decision.

    Heuristic Simplification
    We can also scope out a bucket that is often called heuristic simplification. Heuristic simplification refers to information-processing errors.

    Emotion
    Another behavioral finance bucket is related to emotion, but we’re not going to dwell on this bucket in this introductory session. Basically, emotion in behavioral finance refers to our making decisions based on our current emotional state. Our current mood may take our decision making off track from rational thinking.

    Social Influence
    What we mean by the social bucket is how our decision making is influenced by others.

    Watch this video for an example on herd mentality

    Loss Aversion

    Loss aversion is a tendency for investors to fear losses and avoid them more than they focus on trying to make profits. Many investors would rather not lose $2,000 than earn $3,000. The more losses one experiences, the more loss averse they likely become.

    The key idea behind the loss-aversion bias is that people react differently to positive and negative changes of their status-quo. More specifically, losses are twice as powerful compared to equivalent gains. 

    Loss aversion explains why people tend to overweight small probabilities to guard against losses.

    Watch this video for an example on loss aversion

    Framing Cognitive Bias

    Framing is when someone makes a decision because of the way information is presented to them, rather than based just on the facts.

    In other words, if someone sees the same facts presented in a different way, they are likely to come to a different conclusion about the information.

    Investors may pick investments differently, depending on how the opportunity is presented to them.




    Watch this video for an example on framing cognitive bias

    Narrative Fallacy

    The narrative fallacy occurs because we naturally like stories and find them easier to make sense of and relate to.

    It means we can be prone to choose less desirable outcomes due to the fact they have a better story behind them.

    This cognitive bias is similar to the framing bias.




    Watch this video for an example on narrative fallacy

    Anchoring Bias

    Anchoring bias is the idea that we use pre-existing data as a reference point for all subsequent data, which can skew our decision-making processes

    If you see a car that costs $85,000 and then another car that costs $30,000, you could be influenced to think the second car is very cheap

    Whereas, if you saw a $5,000 car first and the $30,000 one second, you might think it’s very expensive




    Watch this video for an example on anchoring bias

    Confirmation Bias

    Confirmation bias is the idea that people seek out information and data that confirms their pre-existing ideas

    It can be a very dangerous cognitive bias in business and investing

    Examples of confirmation bias:

  • Not seeking out objective facts
  • Interpreting information to support your existing belief
  • Only remembering details that uphold your belief
  • Ignoring information that challenges your belief

    Watch this video for an example on confirmation bias

    • Hindsight Bias

    Hindsight bias is the theory that when people predict a correct outcome, they wrongly believe that they “knew it all along”.

    It explains the tendency of people to overestimate their ability to have predicted an outcome that could not possibly have been predicted.

    Three levels of hindsight bias:

  • Memory Distortion - "I said that would happen"
  • Inevitability - "It had to happen"
  • Predictability - "I knew that would happen"

    Watch this video for an example on hindsight bias

    • Representativeness Heuristic

    Representativeness reuristic is a cognitive bias that happens when people falsely believe that if two objects are similar then they are also correlated with each other. That is not always the case.

    Heuristics are cognitive shortcuts or rules of thumb that are used when one must make a decision but lacks either ample time or the accurate information necessary to make the decision.

    Heuristics are advantageous in that they aid in quick decision making, but the use of heuristics can lead to inaccurate predictions.



    Watch this video for an example on representativeness heuristic

    Handling Bias