Managing behavioural pitfalls
October 16, 2023 by Peter Muldowney
Whether you realize it or not, behavioural biases and influences can lead to ineffective committee meetings and outcomes. However, having an awareness of their impact can not only contribute to making better decisions, but also improve portfolio returns. A combination of good investments and good behaviour is the recipe to achieving optimal outcomes.
Behavioural pitfalls can take many forms, such as the implications of not fully appreciating the likelihood of an occurrence or having a tendency to emotionally anchor consideration of alternative options to the current state of play. This article discusses these and other common pitfalls.
One common pitfall is our tendency to underestimate the likelihood of an occurrence. Our assessment is often too focused on possible outcomes, whereas focus should be on the most likely or probable outcome. Another pitfall is not taking advantage of learnings from our experiences when reviewing different options. Taking advantage of our experiences increases the odds of making better-informed future decisions.
Anchoring is a tool used by car salespeople, where sticker prices on cars in a lot are much higher than what the buyer ends up paying. The sticker price anchors negotiations for the salesperson, but makes the buyer feel like they got a good deal when paying less than sticker price. Anchoring is one bias that plagues most investment committees when undertaking an asset mix review. Potential changes are compared to the current mix, which can make it emotionally difficult to stray too far from this mix. Moreover, such an emotional attachment may not be in the best interest of meeting the strategic goals.
Decision fatigue is a pitfall that most of us experience, but may not realize. It comes about when the number of decisions made in a day leads to our resolve being depleted and we put off decisions, or worse make bad ones. One cause of the fatigue is low glucose levels, which affects our decision-making energy.
Chip and Dan Heath refer to narrow framing, confirmation bias, short-term emotion and overconfidence as the “Four Villains” in their book “Decisive”1. You have a decision to make, but narrow framing makes you miss options. Think of narrow framing as a spotlight shining on one area of a stage where everything else that could be important is in the dark and is therefore not being considered.
When analyzing different options confirmation bias leads you to gather self-serving information. When too much focus is on information that confirms your personal viewpoint, and less weight on information that goes against your view, it can lead to an under-appreciation of the risks associated with a decision.
When you make a choice, short-term emotion can lead you to make the wrong one. Short-term emotion is most problematic for difficult decisions, where our feelings can adversely affect the decision with our heart ruling our head.
In making your decision, you can be overconfident of the future outcome. Overconfidence is an unfortunate state of mind where you believe you know more than you do about how the future will unfold, which understates the uncertainty associated with decisions.
Managing behavioural biases
Behavioural pitfalls cannot always be avoided, but they can be managed.
Figure 1: Managing the pitfalls
|Behavioural pitfalls||How best to manage|
|Assessing the odds||Focus on the probable|
|Memory recall||Be prepared|
|Anchoring||Be open to ways to limit|
|Decision fatigue||Early is best; review strategic items first, have breaks and snacks|
When assessing choices, it is important to understand the likelihood of an occurrence and focus your efforts and energy on the probable outcomes. When retrieving a memory your brain “replays” the nerve pathways created when the memory was formed. Recalling information helps strengthen our memories, highlighting the importance to be prepared for meetings in order to benefit from experiences and past learnings.
Being aware that some biases exist goes a long way to limiting their influence. When it comes to other biases such as anchoring, it is important to be open to ways to reduce influences. For example, when undertaking your next asset mix review, disguising the different mixes can help manage the risk of an emotional attachment to the current mix.
To combat decision fatigue, the best option is to schedule meetings early to improve the odds of making effective decisions. If meetings late in the day cannot be avoided, then agenda items should be organized with the most important first, when energy levels are higher. Having snacks available to provide a recharge of energy levels will also improve decision-making.
Managing the four villains
The “WRAP” process can help tackle each of the four villains.
Figure 2: Managing the villains
|Four villains||WRAP process|
|Narrow framing||Widen your options|
|Confirmation bias||Reality-test your assumptions|
|Short-term emotion||Attain distance|
|Overconfidence||Prepare to be wrong|
Widening options can uncover ideas that you may not have thought of and helps to avoid narrow framing. The concept is to think of physically moving the spotlight away from the area previously focused on in order to uncover different ideas or options. For example, if your committee is struggling with a particular challenge, reach out to a peer in the industry to find out how they tackled a similar challenge as a way to widen your perspective.
One approach to take when faced with confirmation bias is to reality-test assumptions by having someone play a devil’s advocate role to create constructive challenges and discussion prior to finalizing the decision.
To manage short-term emotion consider putting some distance between reviewing options and making a decision. The “10/10/10” tool developed by business writer Suzy Welch provides an elegant way of requiring us to put some distance when assessing decisions. Imagining how we will feel 10 minutes, 10 months and 10 years from now can help alleviate the emotional impact, since the longer the timeframe, the less the impact from emotional influences.
For overconfidence, you should prepare to be wrong, no matter how confident you may be. Having an appreciation that there is a risk things may not go exactly as planned can create an important awareness when assessing options.
Making better decisions
Sitting on an investment committee is a role where many decisions are required. While you cannot control how investments will perform, you can manage how behavioural influences and biases can negatively affect decisions. By doing so, you will improve the odds of meeting your long-term goals.
 Heath, Chip., and Dan Heath. Decisive: How to Make Better Choices in Life and Work. New York: Crown Business, 2013.