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Smart People, Dumb Decision

Smart People, Dumb Decision

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Published by: CorpDevGuy on Jul 09, 2010
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you ask people to offeradjectives that they asso-ciate with good decision mak-ers, words like “intelligent”and “smart” are generallyat the top of the list. Yet,history contains plentyof examples of smartpeople who madepoor decisions as theresult of cognitivemistakes. Thesemistakes can havehorrific conse-quences, from the spaceshuttle
disaster tothe scores of bank failuresacross the United States sincethe start of the 2007 recession.But faulty decision making isalso avoidable. Every day, researchis offering new insights into the de-cision-making process. A science of choice is emerging, and the goodnews is that everyone, from studentsto stockbrokers, can learn how tomake better decisions.Smart people make poor decisions because the mental software that wehumans inherited from our ances-tors isn’t designed to cope with thecomplexity of modern day problems
Smart People,
Chances are you’re unaware of the limitsto your abilities, unappreciative of thechallenges that lie ahead, and uninformedof all that can go wrong. Don’tworry you’re not alone.
© 2010 World Future Society7910 Woodmont Avenue, Suite 450, Bethesda, MD 20814, U.S.A.All rights reserved.
March-April 2010
likely success on a grammar test. The bottom-quartile performers dramati-cally overstated their ability, think-ing that they would be in the next-to-highest quartile. Furthermore,even when individuals do acknowl-edge that they are below average,they tend to dismiss their shortcom-ing as inconsequential.The second is the illusion of opti-mism. Most people see their futureas brighter than that of others. Forexample, researchers asked collegestudents to estimate their chances of having various good and bad experi-ences during their lives. The students judged themselves far more likely tohave good experiences than theirpeers and far less likely to have badexperiences.Finally, there is the illusion of con-trol. People behave as if chanceevents are subject to their influence.In one study, researchers asked twogroups of office workers to partici-pate in a lottery, with a $1 cost and a$50 prize. One group was allowed tochoose their lottery cards, while theother group had no choice. Luck de-termined the probability of winning,of course, but that’s not how theworkers behaved.a moment to answer (honestly!) thefollowing questions either Yes or No:
to judge humor.
places me in the top half of my orga-nization.If you are like most people, yousaid “yes” to all three questions. Thisshows the illusion of superiority,which suggests that people have anunrealistically positive view of them-selves. Of course, not everyone can be above average. In a classic 1976survey, the College Board asked highschool test takers to rate themselveson a host of criteria. Eighty-five per-cent considered themselves abovethe median in getting along with oth-ers, 70% above the median in abilityto lead others, and 60% above themedian in sports. One surveyshowed that more than 80% of people believed that they were moreskillful than half of all drivers.Remarkably, the least-capablepeople often have the largest gaps between what they think they can doand what they actually achieve. Inone study, researchers asked subjectsto rate their perceived ability andand systems. In short, smart people,like everyone else, face two majorobstacles to making good decisions.The first obstacle is the brain, whichevolved over millions of years tomake decisions unlike what we facein modern life. The second obstacleis the growing complexity of theworld in which we live.
Overconfidence: The BiggestFactor in Poor Decisions
Our natural decision-making pro-cess makes us vulnerable to certainmental mistakes. One example iswhat psychologists call the “insideview,” which explains that we con-sider problems by focusing on a spe-cific task, use information that is closeat hand, and make predictions basedon that narrow and unique set of in-puts. This approach is common for allforms of planning and almost alwayspaints too optimistic a picture.Overconfidence, in one form or an-other, is central to the inside view,and can lead to three illusions thatcan derail decisions: the illusion of superiority, the illusion of optimism,and the illusion of control.To introduce the first illusion, take
Dumb Decisions
By Michael J. Mauboussin
March-April 2010
tion. After about a year, they hadwritten a couple of chapters for thetextbook and had developed somesample lessons.During one of their Friday after-noon sessions, the educators dis-cussed how to elicit informationfrom groups and how to think aboutthe future. They knew that the bestway to do this was for each personto express his or her view indepen-dently and to combine the views intoa consensus. Kahneman decided tomake the exercise tangible by askingeach member to estimate the date thegroup would deliver a draft of thetextbook to the Ministry of Educa-tion.Kahneman found that the esti-mates clustered around two yearsand that everyone, including thedean, was between 18 and 30months. It then occurred to Kahne-man that the dean had been involvedin similar projects. When asked, thedean said he knew of a number of similar groups, including ones thathad worked on the biology andmathematics curriculum. So Kahne-man asked him the obvious question:“How long did it take them to fin-ish?”The dean blushed, then answeredthat 40% of the groups who hadstarted similar programs had neverfinished, and that none of the groupscompleted it in less than seven years.Seeing only one way to reconcile thedean’s optimistic answer about thisgroup with his knowledge of theshortcomings of the other groups,Kahneman asked how good thisgroup was compared with the oth-ers. After a pause, the dean re-sponded, “Below average, but not bymuch.”While people are notoriously poorat guessing when they’ll completetheir own projects, they’re prettygood at guessing when other peoplewill finish. In fact, the planning fal-lacy embodies a broader principle.When people are forced to look atsimilar situations and see the fre-quency of success, they tend to pre-dict more accurately. If you want togot about it.Markets also have a good dose of randomness, assuring that all inves-tors see good and poor results fromtime to time. Despite this evidence,active money managers behave as if they can defy the odds and delivermarket-beating returns. These invest-ment firms rely on the inside view to justify their strategies and fees.A vast range of professionals com-monly lean on the inside view tomake important decisions, with pre-dictably poor results. This is not tosay that these decision makers arenegligent, naïve, or malicious. En-couraged by illusions, most believethey are making the right decisionand have faith that the outcomes will be satisfactory.
On Time and within Budget Maybe Next Time
 Just as our faulty brains are natu-rally inclined toward overly optimis-tic perception of our abilities, we alsohave a funny, and faulty, view of time. You will be familiar with thisexample if you have ever been partof a project, whether it involved ren-ovating a house, introducing a newproduct, or meeting a work deadline.People find it hard to estimate howlong a job will take and how much itwill cost. And when they are wrong,they usually underestimate the timeand expense. Psychologists call thisthe planning fallacy. Here, again, theinside view takes over as the major-ity of people imagine how they willcomplete the task. Only about one-quarter of the population incorpo-rates the base-rate data either fromtheir own experience, or from that of others, while laying out planningtimetables.Years ago, Daniel Kahneman, apsychologist who won the NobelPrize in Economics, assembled agroup to write a curriculum to teach judgment and decision making tohigh-school students. Kahneman’sgroup included a mix of experiencedand inexperienced teachers as wellas the dean of the School of Educa-Before the drawing, one of the re-searchers asked the participants atwhat price they would be willing tosell their cards. The mean offer forthe group that was allowed to choosecards was close to $9, while the offerfrom the group that had not chosenwas less than $2. People who believethat they have some control have theperception that their odds of successare better than they actually are.People who don’t have a sense of control don’t experience the same bias.I must concede that my occupa-tion active money manage-ment may be one of the best exam-ples of the illusion of control in theprofessional world. Researchers haveshown that, in aggregate, moneymanagers who actively build portfo-lios deliver returns that are lowerthan the market indices over time, afinding that every investment firmacknowledges. The reason is prettystraightforward: Markets are highlycompetitive, and money managerscharge fees that diminish returns.The same is true for individuals.Even though doing a lot of researchinto what to buy and sell may giveyou confidence, over time the costsyou incur make it likely that yourportfolio returns will fail to keep upwith someone who parked money ina garden-variety index fund and for-
“While people are noto-riously poor at guessingwhen they’ll completetheir own projects,they’re pretty good atguessing when otherpeople will finish.”
March-April 2010

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