Our built-in biases can mean poor investments and missed opportunities. But there are tried-and-true methods
for overcoming them.
Being a successful investor is all about making good decisions. But our brain’s hardwired biases, originally designed to keep us alive when we were hunter-gatherers, frequently get in the way of rational decision-making.
With only four per cent of investments yielding greater than 10x returns, it pays to work on your decision-making skills.
Professor Jill Klein, who specialises in leadership and management at the Melbourne Business School and has taught into our VC Catalyst program, says some of the ‘judgemental biases’ that tend to trip us up are overconfidence, framing and confirmation bias.
The good news? There are techniques for overcoming them all.
It’s likely you’re overestimating yourself much of the time; almost all of us are. 82% of people say they’re in the top 30 per cent of drivers and 86% of Harvard Business School MBA’s think they’re better looking than their classmates.
But over-confidence has more serious consequences than misplaced vanity. It leaks into our day-to-day business decisions. How often have you seen construction costs exceed original estimates, project plans underestimate timelines or strategic plans ignore competitor responses?
The same goes for venture capitalists. In fact, research has shown 96% were overconfident in their decisions, making them less accurate in their assessment of startups.
“There is very little correlation between how confident a person is, or appears to be, and accuracy,” says Professor Klein.
To beat over-confidence, Professor Klein recommends:
- separating deciding from doing – be a realist when deciding and confine optimism to doing;
- working with others – the average judgement of a group is almost always better than an individual’s judgement (but balance this with the need to maintain disruptive thinking);
- considering other options – decisions improve dramatically if there is at least a second option; and
- not demanding over-confidence from others.
There are multiple ways to look at any decision. Does an old piece of furniture have ‘rustic charm’ that means it should be kept, or is it ‘junk’ that should be thrown out?
Framing is constantly influencing how we interpret reality; both our own frames and the frames other people use to present problems to us. The problem of drug abuse, for example, has very different solutions depending on whether it’s framed as a law and order issue, or a public health issue.
Professor Klein suggests asking yourself the following questions to uncover the frames you’re using (probably unconsciously):
- what issues does the frame address most?
- what boundaries do I put on the problem? In particular what aspects of the situation do I leave out of consideration?
- what yardsticks and reference points do I use to measure success?
- what metaphors, if any, do I use in thinking about this issue?
- why do I think about this question this way? What training of experiences frame the way I view the world?
- what does the frame emphasise or minimise?
- do other people in my industry think about this problem differently? How? Why? Are their frames successful?
To understand how a problem has been framed for you, she suggests asking:
- has the wording of the problem created a frame? What is it overlooking?
- do the options create a frame?
- is there an alternative question that leads to a broader frame?
She also recommends talking to people with a different frame, like someone from a different industry or someone you tend to disagree with.
Confirmation bias is our tendency to prefer information that is consistent with our beliefs, expectations, preferences and desires. It is, perhaps, the best-known judgemental bias, and it’s certainly one of the most common.
Do you tend to agree with the posts you read on Facebook? That’s most likely down to confirmation bias; the information you see is reinforcing what you already believe because, chances are, you follow organisations and individuals that share your world view.
For investors, going with solutions or teams that conform to your worldview can mean missed opportunities. Overcoming confirmation bias to assess pitches with truly fresh eyes isn’t easy, but it can be done. Professor Klein recommends:
- searching for both confirming and disconfirming information;
- entertaining multiple hypotheses and testing both side of each;
- playing devil’s advocate with yourself;
- doing a ‘pre-mortem’, where you imagine failure – what went wrong, and why?
- pretending disconfirming information (the data that doesn’t support your pre-existing beliefs) is accurate – at least temporarily.
We all have other biases at work, too. Professor Klein recommends investors look out for ‘anchoring bias’, which is when an initial starting point has undue influence over subsequent decisions. It can throw out everything from valuations to project timelines.
And our tendency to double-down on decisions once we’ve thrown a lot of money at them, or ‘sunk cost bias’, can all too often steer investments off-course.
Overcoming judgemental biases is challenging and experts agree that being aware of your own biases, while useful, isn’t enough on its own.
Taking deliberate, practical steps to overcome them is much more likely to lead to rational, and therefore better, decisions.