3 Most Common Human Fallacies in Decision-Making

Our brain has evolved as the most extraordinary machine ever created by nature. On the other hand evolution makes our progresses happen in million of years, while humanity progresses at a much faster pace. For such reason our mind still carries some built-in biases and fallacies that are part of our nature (evolution did not wipe them out yet). Three of those fallacies influence our ability to make good decisions:

1. Availability cascade: A terrorist attack strikes in the central station of your city. No people died, just dozens of injuries, fortunately nobody’s life has been taken away. However the images of the event left a sign in your memory (a dear friend remained injured in the attack). You used to take train to work and because of the attack you decided to ride a car. Life is much more stressful now. You commute for almost two hours everyday since the traffic in the city is very bad. On the other hand you don’t mind it, since at least you feel safer now. One day, coming back from work, a push up notification on your (super-smart) phone distracts you for one instant from looking at the road ahead. Unluckily for you in that instant, a traffic jam is forming. You are not able to stop your car quickly enough to avoid the accident. Three people are killed and luckily you are just injured. However the burden of three people to carry on your conscience is too heavy to bear. In that moment you realized that probably it would have been better to take the train instead of driving. Statistics in US show that traffic accidents cause way more victims than terrorist attacks although we can’t help thinking about terrorism due to its emotional impact. Beware of statistics before making a decision.

2. Bias toward abstract situations: Our brain does not deal well with abstract situations. For example, even though we are averse to losses, this does not necessarily imply that we are averse to risk. Shouldn’t the two things be connected? Yes and Not. Of course a higher risk implies higher chances of losing money. The problem is that risk is an abstract concept and we hardly get it. Therefore, just when we are presented with the concrete loss that we finally realize the risk. In other words as psychologist Daniel Kahneman would state, although we think of Entrepreneurs as brave people, realistically they are not aware of the risk they are actually taking.      In other words it is not that most entrepreneurs are more courageous on average, rather they are not able to understand the implied risks of their investments. Kahneman uses an example to represent our bias toward abstract situations:

If I say a vaccine will kill 0.001% is different than I say one on 100,000

Why? In the moment in which 0.001% becomes one on 100,000 suddenly our brain is able to see the effective risk (a person will die, rather then a simple percentage). Therefore, our brain will represent it. Beware of our inability to understand abstract situations.

3. Hindsight Bias and Narrative fallacy: One day Carlo decided to invest some money in stocks. After performing an analysis on the stocks he wanted to buy and determined the purchasing price, he eventually bought a Company called “Fallimento.” The stocks were supposed to go up but unfortunately this did not happen. Actually, the stocks started to plummet right after Carlo bought them. What was wrong with the choice he made? Carlo recognized the analysis to be good, the timing also. Eventually the most popular business channel spread the news that the stock fell due to an offer made by another company, and the offer was deemed too low by the market operators. As soon as Carlo heard the news it made perfect sense to him. He told himself that Fallimento had strong financial ratios and the explanation given by the chief journalist was so well articulated that it made perfect sense. Therefore Carlo held Fallimento’s stock. Eventually though, the stock kept plummeting until the CEO of Fallimento interviewed at the local TV declared, “we just filed for Chapter 7, our institution founded 150 years ago was not able to repay its debt due to unexpected losses.” The news spread, newspapers, TV, Social Media harried up to condemn what had just happened. All agreed that Fallimento deserved to fail. For everyone was plain clear that this company was destined to failure. How could Carlo have missed it this time? This story carries two biases. First, when Carlo accepted the explanation of the chief journalist he fell in what is called “Narrative Fallacy” (our innate tendency to rationalize things). In other words, our brain is wired to find explanations to anything. In the second instance when Fallimento eventually failed, everyone seemed to find plain clear that it would have happened. The same Carlo was surprised not to have noticed it before. This is the power of the “Hindsight Bias.” Things make sense at hindsight, but in the moment in which the decision was supposed to be made things did not look so clear at all. Narrative fallacy and hindsight bias seem to come from the same kind of delusion, our propensity to rationalize. Beware of rationalization. You may end up justifying the unjustifiable.

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Gennaro Cuofano, International MBA. Author of "The Enlightened Accountant," and "The Art of Mentorship."

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