Humans are a bucketful of biases

We can be blind to the obvious, and we are also blind to our blindness.

Daniel Kahneman

Decisions we make, as investment professionals, are very important for our clients’ wealth and wellbeing. This goes for the whole investment industry, especially for those in wealth management. That is why Thinking Ahead Institute spent over a year researching this topic in 2018. And why it is just as relevant today.

Individuals and groups are prone to errors in judgment. Sometimes it’s random and sometimes it’s because of our biases. And let’s be honest, humans are a bucketful of biases.

Daniel Kahneman talks about this in his bestselling book Thinking, Fast and Slow. He says our brains have two main modes: System 1 and System 2. System 1 is quick and instinctive, while System 2 is slower and more logical.

System 1 is always tossing ideas to System 2 based on our gut feelings and first impressions. But sorting through all this can be tricky.

Imagine you’re driving a car and suddenly encounter a roadblock. Your immediate reaction (System 1) might be to hit the brakes or swerve to avoid the obstacle. However, you also engage System 2 thinking to assess the situation more carefully. You consider the signage, traffic cones, and workers around to make a reasoned decision about the best course of action. System 1 reacts quickly to the unexpected situation. System 2 provides the necessary analysis and decision-making to navigate safely.

However, both systems are prone to biases. Our senses are collecting information all the time, most of which is irrelevant to the decision you are making. Over 11 million pieces of information hit our brain every second, but our conscious mind can only deal with about 40 pieces of them.

This is bad news for decision making because System 1 does not produce meaningful narratives when it sends ideas over to System 2. And System 2 cannot deal with lack of meaning or with information overload.  

To cope, our brains filter aggressively and make mental shortcuts. Financial planners and clients frequently utilise these mental shortcuts when processing large amounts of data, leading to errors in judgment.

One of these shortcuts is confirmation bias. This is when we only look for, interpret, favour, and recall information that backs up what we already believe.

For example, a client, who loves real estate, seeks out news and cherry picks data that supports their instinctive preference (System 1) without embracing deeper analysis (System 2). Then they ignore advice to diversify their investments and end up losing big when the real estate market crashes.

To deal with bias, planners need to get to know their clients investing and risk-taking profiles. They also need to come up with investment approaches during calm times to prepare for bumpy markets. And they should back up their advice with data, not just gut feelings. Looking back on past experiences with other clients can also help spot bias and guide their clients toward better choices. And of course, advisers should act in their client’s best interest. This is all about professionalism and ethics.

And it’s not just clients who fall into this trap, it’s financial planners too. They might get too hyped about a certain investment, like renewable energy, because they consider themselves ‘green’. So, they overlook the risks and there’s trouble when things go south.

To combat this, planners and their teams must recognise their own bias. They can use tactics like pre-mortems, storytelling, and getting different perspectives from inside and outside their team to make smarter decisions. And most importantly they can improve the level of cognitive diversity in their team. Cognitive diversity leads to different perspectives on the future. Which leads to better decisions and better investments.

In short, it’s vital for every investor, no matter their experience or what they’re investing in, to consider their biases. Even though it’s uncomfortable, taking a good look helps reduce risks and enables smarter decisions.

Moreover, stay mindful of both systems of the brain. By enhancing your intuitive thinking with critical thinking, you can reduce biases and achieve a more harmonious balance between thought and emotion.

If you are interested in Thinking Ahead Institute presenting to your team on this topic or another contact us.