Who’s afraid of the Big Bad Bias?

Humans are a weird bunch. We oscillate between rationality and irrationality. We develop probability theories and then we don’t use them.

We do odd things like differentiate between “fun money” and savings, as though there are two types of money in this world. We spend differently depending on where the money came from, even though money is perfectly fungible.

We are weird, but we are fascinating.

We use heuristic techniques all the time. That’s just a fancy description for a rule of thumb – the good old 80/20 principle that allows us to function in a world of imperfect data and at times unbearable time pressures.

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These quick decisions are fraught with cognitive biases.

Why is something that you built yourself always more valuable to you than something that you bought for the same monetary value?

Why do people say “well, we’ve come this far” when making a decision, implying that the thought of wasted effort is more painful than the reality of making the wrong choice?

Have you ever given a quick answer under pressure and then found it incredibly difficult to materially budge people from that number, even though you can clearly show that it was wrong?

How often do startups describe themselves as “the Uber of this” or “the AirBnB of that”? It’s so much easier than trying to explain the concept of these businesses from scratch. It’s a sensible approach because we have a cognitive bias towards things that are familiar to us. It feels less risky somehow. It also feels like the success of the familiar concept may be repeated in the new concept.

To pretend that these things can be entirely overcome would be to deny our psychology as humans. There’s no getting away from it: cognitive biases are here to stay.

You can’t avoid cognitive biases, but you can catch them

Optimism, at its core, is a cognitive bias.

“This time, it will be different.”

“It won’t happen to me, I’ve got this.”

It’s also the core ingredient to any entrepreneur’s success. That’s why you can’t avoid the bias, but you can catch it.

You need to be optimistic, but you need to challenge your own assumptions. Think of as many reasons as possible why this idea might fail and what you can do to mitigate the risks. Build the best financial model you can, even if it is simplistic, to test things like break-even point and sensitivities to things not going as planned.

It’s tough to walk away, but it feels better to pivot

By the time you’ve invested many hours in a project and probably some capital, the last thing you want to do is acknowledge that it’s not going to work. You’ve become emotionally invested in this idea.

It’s “your baby”, right?

The concept of sunk costs is easy to explain but far more challenging to apply. To make it slightly more enjoyable, let’s relate it back to a movie we all know and love. “Hakuna Matata” was an important part of The Lion King. It’s in the past, so it doesn’t matter.

The decision to walk away or pivot should always be forward-looking. A useful technique is to introduce go/no-go milestones into a project. Lift your head at agreed intervals and assess whether you should still be going down this path.

Of course, a pivot means that some of your hard work might be salvageable, which will be an easier pill to swallow than completely giving up. That doesn’t always make it the right decision, though. Sometimes you genuinely need to walk away.

Be careful of finding what you’re looking for

You want to buy a new family car. After researching it for a few days, you’ve settled on a specific Mercedes-Benz. On your commute the next day, you start noticing them everywhere!

“It’s amazing how many of them are on the road. Clearly a popular car, we’ve made the right choice,” you proudly tell your significant other that evening. Of course, had you chosen the BMW instead, you would’ve noticed just as many on the road that day.

Confirmation bias is perhaps most dangerous of all. We love finding ways to prove we were right; to confirm our pre-existing beliefs. If you’re looking for something, you’ll usually find it. The problem is that you can easily become blind to the reality, while you blissfully carve out a convenient truth and latch onto it.

Get a mentor or hire a team of thinkers

If you simply want to hire another pair of hands that will do exactly as you say, then add another yes-man to your team. These people never criticise or question their superiors, either because it isn’t in their natures or because they aren’t knowledgeable enough to do so. Every company needs worker bees, but be careful of only having worker bees.

Your own biases will be allowed to roam free and cause all kinds of trouble if you don’t immerse yourself in an ecosystem of thinkers. Whether these are your mentors or your executive employees, a culture of debate and courageous conversations is the best way to defend yourself against the mistakes of cognitive biases.

It feels good to be told that you’re right, but it’s far more valuable to be told why you’re wrong.

This article is a collaborative effort between The Finance Ghost and Arete Advisors – all rights reserved.

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