Why We Make Bad Decisions

February 20, 2019 Uncategorized

In Jim Collins’ famous book Good to Great (Why Some Companies Make the Leap and Others Don’t), he says that, “One of the dominant themes from our research is that breakthrough results come about by a series of good decisions, diligently executed and accumulated one on top of another.”

That begs the question, how does an individual or organization make “good” decisions or conversely avoid the “bad” ones? It’s a big question, one that I continually try to explore but in no way feel qualified to answer. One thing that has become clear to me is my poor decisions are generally rooted in some subtle behavioral blind spot like ego, unknown biases or fear.

If you follow Warren Buffett and his business partner, Charlie Munger, they both spend a lot of time talking about how they make decisions. Charlie Munger became so fascinated with the topic, that he gave a famous speech in 1995 called, “The Psychology of Human Misjudgment” about the ways people trick themselves into making errors of judgment. The full speech can be found on YouTube, but I will warn you it is very long and terribly dry. There is, however, a 15-minute abbreviated and animated version titled, “Charlie Munger: The Psychology of Human Misjudgment” that is very good.

Here are a few examples he gives during his speech that I have either experienced firsthand and/or noticed in some contractors when making business decisions.

Bias from Over-Influence from Authority
We are all at some point influenced by authority figures. Whether it was a teacher when we were little kids or an expert in their field such as a doctor or stock broker as adults. The problem is we sometimes blindly take the information they give us as gospel instead of critically thinking about whether we agree.

Charlie Munger uses the example of a study where airline pilots were put in simulations and instructed to do something that would make the plane crash, so the psychologists could observe the reaction of their unaware copilot’s. In 25% of the cases, the copilot took no action and let the plane crash deferring to the pilot authority figure even though there was clearly something wrong.

Ray Dalio, the former CEO of Bridgewater, talks about this concept extensively in his book, Principles. Dalio shares his personal story when he got diagnosed with cancer and his doctor recommended a certain treatment option. Dalio began to research his type of cancer and the treatments available, then he consulted with two other top experts both of which recommended another type of treatment. Based on these recommendations and his own research, he opted for the second treatment option and his cancer was cured. Dalio refers to this as “triangulating decision-making” (i.e. getting a base knowledge of the subject yourself and checking with multiple top experts in the field).

Bias from Social Proof
This one can simply be described as, “Everyone else is doing it, so I should too.” We see this often with the stock and real estate markets. All the people we know are buying stocks or real estate, so it must be a good idea.

With contractors, this can also happen in more subtle ways. You see your competitors buying certain equipment or expanding geographically, and wonder if you should be doing the same.

Munger gives a stark example of when Exxon bought a fertilizer company – something they had no experience in and had nothing to do with the oil business. After a period of time, all of their competitors bought fertilizer companies too – none of which worked out well.

Contrast-Caused Distortion
Human beings often think in terms of contrast and relativity, which is probably the reason reality TV is so popular, as many shows make us feel better about our own lives. Munger gives the example of a real estate agent taking a person to two very overpriced houses and afterward showing them a moderately overpriced house, which then seems like a bargain when in reality it is still moderately overpriced.

In business, it might mean your company made a 5% net profit compared to the industry average that year of 2%. That seems great, but what if the true potential for your company was a 10% net profit? Was 5% really that great?

It can be extremely difficult but equally important to think in absolute terms, and we each have to come up with our own definitions and benchmarks without relying totally on comparing to others.

Gambling Bias
It has been shown that lotteries that allow people to pick their own numbers get significantly more play, because people subconsciously believe they have influence over outcomes of things they don’t.

One of the most important things I believe in life is constantly gaining the clarity of what we can control versus that which we don’t. Only then do we have an honest perspective and the ability to direct our efforts towards those things which we have influence.

Conclusion
Combating the tricks our mind plays on us can be challenging and never-ending. Being aware of these things and our own bad habits or blind spots is a helpful first step.

Reading and learning about how other successful people make good decisions is another very helpful avenue. Like anything in life, it takes practice, practice and more practice to make good decisions. Or as someone said once, “We are what we repeatedly do. Therefore, excellence is not an act but a habit.”