“Jill, this is sergeant Sacker. Listen to me. We’ve traced the call… it’s coming from inside the house. Now a squad car’s coming over there right now, just get out of that house!”
This is the famous line from the 1979 horror film “When a Stranger Calls” letting the terrified babysitter know her would be attacker is in the house. If you’ve not seen the movie, or it’s been a little while, it’s worth checking out.
In today’s dynamic information-overload environment of social media, news and now, fake news, we can find ourselves in an echo chamber (for example, a sports bar outside of Wrigley Field in Chicago filled with only Cubs fans). With that in mind, each of us knows we should take an objective view on new information as we receive it, but that doesn’t mean that our brains are cooperating.
Financial losses are processed in the same area of the brain that responds to mortal danger, so losing money in the stock market is treated the same as the threat of being eaten by a lion.
This threat makes us want to pull money out of an investment when it goes down in value. Similarly, our minds scream “run” if we encounter a hungry predator like a lion. With investments, the loss has already occurred—the value has gone down (you’ve been eaten by the lion)—so it may be wise to leave your money in the investment with the knowledge that it could go back up to its previous value.
There are dozens and dozens of cognitive biases we can fall prey to and in order to avoid doing so, we need to be aware of them. Those that relate to investing behavior include:
- Overconfidence Bias– We’re more confident in our abilities than we really are. “I’m an excellent driver and all the other drivers are not.” “I’m better at spotting investment opportunities than others.”
- Illusion of control– If we invest only in the things we are familiar with, somehow we have more control over our portfolios. “I worked at GE for 30 years, so I know it will always be a great investment.”
- Regret avoidance– Once bitten, twice shy. “My 401(k) at my last job went down so I’m not going to participate at my new job because that will likely happen again.”
- Loss Aversion– How we deal with losses as opposed to how we deal with gains. Often, the pain or fear of loss can be twice as strong as the potential for gain. “I’d rather invest in more conservative vehicles so I don’t lose money.”
On a broader scale, Confirmation bias, the most common bias, is very important to be aware of in today’s polarized world. Often referred to as “myside bias,” it’s the tendency to seek out information that justifies our pre-existing beliefs. This can manifest itself in almost every aspect of our lives, for example going to the Boston Globe for information on the Patriots.
Knowing that our minds can play tricks on us, it can be helpful to play devil’s advocate with ourselves; to clarify our current thinking or position on an issue and to then seek out the other side. As Americans, if half of us can’t have a civil dialogue with the other half on many of the major issues of today, we’re in for a rocky future.