Are you biased?
Which orange dot is bigger? Ebbinghaus Illusion. Source: Wikipedia
No one wants to be, but we all are. There are systematic ways that everyone looks at their experiences, information, and lives. These biases are hard-wired into us—some of them are part of every living thing. Some years ago a prominent psychologist used the phrase, “preferences need no inferences” to describe how chicks that hatch from eggs exposed to certain types of music continue prefer that kind of music as adult chickens. We’ll get to that later, but his experiment shows that choices can be formed independent of any rational thought process.
Our biases don’t just affect the way that we look at the world. They influence what we choose to look at in the first place. In many ways, our biases are like a language: they give us the categories we use to classify things. Eskimos famously have 50 words for snow; Bedouins have over 100 words for camels or the parts of a camel.
Biased judgements are a typical—and systematic—investment error. Other errors include overconfidence, loss aversion, and herd mentality. The bad news is, these mistakes—if uncorrected—push to do the wrong thing at just the wrong time. They rob us of the returns we need to meet our investment goals—saving for college, or for retirement, or to create a legacy.
The good news is we can compensate for them. If everyone is making the same mistakes and we know the kinds of mistakes our genes and our conditioning and our social nature make us susceptible to, we can look out for these errors. That doesn’t mean it will be easy. But it does mean we can say to ourselves: “Aha! This is a situation where the herd is running. I’d better double-check my accounting/math/what-if analysis.”
Shakespeare once wrote, “The wish is father to the thought.” Because we want something to be so, we act as if it’s already true. But reality bites. And if we can name our biases ahead of time, we just might avoid a few potholes along our investing journey.
Douglas R. Tengdin, CFA
Chief Investment Officer