Putting biases to work can be a strategy for better investment decision-making

The most important skill in life is great decision making. And yet, were never taught how to make great decisions. Rather we stumble from one mistake to another, making our way hopefully to wisdom.

Even worse, some other individuals exploit our biases for profit. Marketers use behavioral psychology to design advertisements and websites that keep us clicking and buying: believe flash sales, impulse purchases, and celebrity endorsements. From this we conclude that individual biases make us weak. Optimal behaviour is to suppress emotion and rather create calculated, rational decisions, like a computer.

But what if we believed about cognitive biases differently? Imagine if we treated these as the boon of tens of thousands of years of development? They enable us to detect patterns from several cases, to imagine things weve never seen, and to function robustly in a changing atmosphere. Can we design decision-making procedures which capture the advantages of individual prejudice with no drawbacks? Can we tap the non-rational to become even more rational?

I believe we could. We could become post-rational, leveraging rather than bashing our biases. I provide strategies that transform our cognitive weaknesses into strengths. I focus on the investing domain given my experience as a hedge fund manager, but I firmly believe the thinking transfers to other disciplines that require balancing rationality and intuition (e.g. the intellect business, medical diagnosis, hiring, entrepreneurship, etc..)


We are wired for storytelling. We create stories to make sense of anything and everything : the past, others, ourselves. We even create stories to explain the inexplicable, such as daily stock exchange movements. Stories provide relaxation by making things appear less random.

But stories may get us in to investing in trouble. Serious allocators, professionals responsible for investing the aggregated billions of retirement accounts, have told me that they will never invest in overweight CEOs since it signals a lack of discipline. Others have told me the opposite: they invest in overweight CEOs since it signals extreme focus. The truth is most likely that weight has little correlation to performance.

Whats happening here’s quite common: we generalize from very few data points and create narratives to rationalize what we see. Were so good at storytelling which we’re able to develop explanations for anything we encounter.

How do we make use of the storytelling genius? Perhaps, rather than create stories to describe what we see we could leverage stories to identify new risks.

As an example, suppose that have been checking whether to invest in a firm. To recognize possible problems, it is normal to ask How can this investment go wrong? This question relies on our theorizing or forecasting skill to elicit risks.

Imagine if, instead, we imagine which have been living in a world where the expense already went awry, and that we write a story explaining what occurred? Research shows that this technique of describing exactly what went wrong prospectivelya Pre-mortemyields richer explanations than asking how something might go wrong. It participates our storytelling ability, asking us to produce narratives, which we know comes naturally to us.

Check it out using a decision youre currently thinking:: tell the story about how it all went wrong. You will uncover important new hazards and develop steps to offset those risks.

Calibration Training

We are overconfident. 90 percent of individuals consider themselves above average motorists. And 75\% of finance managers consider their performance over average. We believe were more proficient than we really are, and that we know more than we actually do.

This is a problem in investingin. Overconfidence leads us to measure the uncertainty of the predictions inaccurately. We wind up taking bets which are too large relative to the uncertainty involved.

Even worse, investment analysts create predictions which take quarters or years to solve. So we simply learn much afterwards whether we’re right or wrong. Compare that to poker players or meteorologists who get opinions on their predictions right away.

Maybe we could create opinions environments to improve our forecasting. Research has proven that calibration training is good at curbing overconfidence. One strategy involves quantifying our uncertainty about a large number of trivia questions, e.g. how sure are you that Newton wrote the Principia following the calendar year 1650? After a few dozen questions, youll start to get a much greater feeling of the actual size of your uncertainty. To mitigate overconfidence, we constantly must demonstrate ourselves how little we know.

Anchoring To The Opposite

Suppose I ask you to bid to a bottle of wine. But first, jot down the last 2 digits of your social security number. Would these 2 digits influence your bid? Experiments have revealed that it will not; the table shows pupils bids on items (rows) according to the last 2 digits of the social security numbers (columns).

The pupils professed that the digits had no effect on their bids. But the table reveals a massive impact: pupils with the biggest digits bid around 3x more for things than pupils with the smallest digits! The takeaway is that our decision making is influenced by what we’re exposed to beforehand.

This anchoring effect can harm investing. As an example, we may be too influenced by the cost we paid for a stock and hold on to it to avoid realizing losses. Or we may be anchored to recent levels of volatility when determining leverage levels, piling more risk into investments when volatility has been low.

If we’re unduly influenced by the stimuli preceding a determination, then it makes a lot of sense to control and pre-select the best stimuli. And what is the greatest stimulation? Well, whats hard in decision making isnt so much choosing wisely from a set of options, but rather imagining all of the alternatives we really have. The easy protocol of thinking about the opposite helps to expand the set of options being considered and avoid narrow framing.

I believe that the best stimuli before a decision are ones which make it easy to take into account the opposite. Thus, for example, we could designate an opposite thinker for significant meetings. Or we could install physical cues (such as the one below) in meeting rooms which remind us to believe the opposite.

Our cognitive biases receive a lot of negative press, however, they are survival tools. And although we spend our time at a computer in a workplace, that doesnt mean our survival tools are immaterial or bad. Rather, we could creatively redesign our environment to harness these tools. Doing so allows us to become post-rational, reclaiming these biases for our own gain.

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