The most important political debate in the UK is not being determined by facts, it is being determined by emotion. Investors must learn this lesson.
Bias, Brexit and why investors must do better
The behavioural psychologist Daniel Kahneman says we think fast and think slow. The slow form of thinking is about reason, logic and deliberation. The fast form of thinking is more instinctive and about emotion. The trouble is, suggests Kahneman, the fast form of thinking dominates. Once we have acted, or formed a view based on this type of thinking, the more rational side of ourselves kicks in and seeks to find logic and reason to justify the decision or action that has already been made.
Kahneman, along with the long deceased Amos Tversky, helped introduce the concept of various heuristics, such as confirmation bias. In the case of confirmation bias, we might form a view about something or someone, and then we seek out evidence that the view is right, ignore evidence to the contrary, thus hardening our initial view.
These heuristics serve a purpose, evolution selected them as they helped promote survival. But then, when they evolved, we were hunter gatherers, living among a small group of people, in which cooperation within this group was vital for survival. Today, we are asked to deal with complex problems which demand rational, logical, slow thinking.
Investing and political judgements are two such examples. Alas, political judgements are dominated by fast thinking, investors must not let their decisions be influenced by such thinking.
Both sides in the Brexit debate are overly influenced by fast thinking. Facts barely come into it.
When Nigel Farage looks affronted, and says how dare ‘they’ say we didn’t understand what we were voting for, he was appealing to our egos to overlook a fundamental truth — no one knows the consequences of Leave, or indeed the consequences of not leaving. No one really understood.
As a species, we are lousy at changing our minds. Keynes once said: “When the facts change, I change my mind.” But then Keynes had one of the finest minds this country has ever produced, few of us are blessed with the ability to do this.
More often, a set of ideas, ideals and maybe our interpretation of certain facts, cause us to form a view. Once this happens, confirmation bias sets in: a robust network of ideas (known as a small world network in network theory) forms, which is extremely hard to dismantle. The internet is an example of a small world network, and the internet was founded to create a network of computers that would be impervious to attack in a nuclear war. If the facts that helped lead us to a decision change, we rarely change our mind, as by then we have formed a network of ideas confirming this initial idea, which can exist even when the initial facts change.
Take as an example, an experiment carried out by Dan Kahan. In his experiment, he took a fictitious example of two groups of people comprising individuals who have a skin rash. One group is given a cream. The results are as follows:
|Rash got better||Rash got worse|
|Group A: Patients who did use the cream||223||75|
|Group B: Patients who didn’t did use the cream||107||21|
Then he selected a group of people as test subjects to determine whether people who used the cream were more or less likely to get better than those who didn’t.
The trick in answering this question lies at looking at the ratios. In fact, a higher proportion of people who used the cream got worse.
Test subjects who were quite good at maths were more likely to get the answer right.
Then Kahan changed the narrative behind the puzzle. Instead of it being about using a cream to help a rash, he applied the same numbers but to the relationship between gun crime and gun laws.
In this case, rationality went out the window. In most cases, whether you got the answer right or wrong depended on your preconceived views and whether those views happened to be in alignment with the numbers.
In the years post EU Referendum, new facts have emerged. Why was the deal negotiated by Mrs May so unpopular? Was it because she was a lousy negotiator, or was it because coming up with a deal that satisfied the majority was impossible? The answer to that depends on your preconceived ideas.
Of course, our view on the topic of leaving or remaining in the EU has got little to do with facts, as a species we would find it difficult to do it in any other way. Emotion is king. I believe Leave won the referendum because it appealed to emotion. Remain merely said leaving would be a mistake — it was lacking in emotion.
The first stage in battling such bias is to understand two things. Firstly that it is there. Secondly, this does not just mean people you disagree with are biased, it means you are biased too. (Err, including me, I guess.)
Investing calls for a cool, hard headed appraisal of facts — emotion must be cast aside, heuristics must not influence your judgement.
The first step into achieving this kind of ‘investing enlightenment’ is to understand that you are not naturally inclined to be like that.
These views are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees