We all make decisions from time to time that leave us wondering, What was I thinking? Even the most intelligent, cautious, well-informed people are not immune to occasional blunders. And those mistakes can be incredibly costly.
Example: Stephen Greenspan, a well-regarded clinical professor of psychiatry at University of Colorado, who studies gullibility and wrote a book in 2008 called Annals of Gullibility: Why We Get Duped and How to Avoid It, lost 30% of his retirement savings in Bernard Madoff’s Ponzi scheme.
Interestingly, whether our decision-making errors occur in our personal, professional or financial lives, they tend to follow predictable patterns. People who learn to identify these patterns — and to spot salespeople, financial advisers and scammers who try to take advantage of the patterns — are likely to make fewer bad decisions.
Six common decision-making mistakes and how to do better…
Mistake 1: We trust stories over statistics. A 2004 study published in Journal of Clinical Psychology in Medical Settings found that patients tend to opt for treatments that are accompanied by stories of other patients’ successful recoveries — and avoid treatments that are accompanied by stories of patients who did not recover — even when the patients are informed that statistically the treatment linked to the negative anecdote is far more likely to be successful. The human brain simply finds it easier to understand and believe stories than statistics.
Example: You are about to buy a Honda because of high scores in vehicle-reliability surveys when a friend tells you about the problems he had with his Honda. Would you buy a different make of car instead? Many people would, though the experiences of the tens of thousands of car owners summarized in vehicle-reliability surveys should mean much more than the opinion of the single car owner with whom you happened to talk.
What to do: Remind yourself to place more weight on statistical evidence than on any one person’s story. If an anecdote proves too powerful to ignore, seek out additional anecdotes that point in the opposite direction, for balance. Consumer-feedback Web sites usually provide a wide range of conflicting personal anecdotes.
Mistake 2: We often think of ourselves as the exceptions. From our own biased perspectives, we’re special and not like everyone else. Thus our minds sometimes think that the statistics and tendencies that apply to everyone else do not apply to us. That means that most of us are pretty good at judging the likely outcomes of other people’s decisions. We run into trouble, however, when we try to predict the likely outcomes in our own lives.
Example: Most people know that kitchen renovations almost always run over their budgets and schedules — yet very few home owners adjust their own renovation budgets and schedules to allow for overages. They’re confident that they’ll get everything done as planned — even if no one else does.
What to do: When you need to construct a schedule, budget or financial plan, pretend you are offering advice to a friend, not doing it for yourself.
Mistake 3: When we hear a number, our mind becomes anchored to that figure. That may severely impede our ability to produce a truly objective numerical estimate or counteroffer.
Example: A group of people were asked to write down the final four digits of their phone numbers. Then they were asked to guess how many doctors there are in New York City. Those with phone numbers whose final four digits formed figures below 3,000 (for example, 555-2200) tended to come up with significantly lower estimates than those whose phone numbers formed figures above 7,000 (such as 555-9200). Their brains were unconsciously influenced by the phone number figure, even though they knew that it was completely unrelated to the estimate they were trying to make. (Correct answer: There are about 20,000 doctors in New York City.)
This anchoring tendency can have costly consequences. If a real estate agent says a home in our neighborhood recently sold for $600,000, our minds start to believe that the value of our home must be close to $600,000, even if the two properties are very different. If a broker tells us that a stock recently sold for $50 a share, its current $30 share price might seem like a tremendous value, even if it isn’t.
What to do: There is no way to escape anchoring entirely. We can strive to anchor our minds to a relevant figure, however. Do some research before making a major purchase, producing a numerical estimate or setting a quantitative target. If you can focus on a useful figure or two — the wholesale cost of the item you wish to buy… the average price paid by other consumers… the price-to-earnings ratio (P/E) of other stocks in the sector — you are less likely to be anchored to an irrelevant figure.
Mistake 4: We let subtle smells, sounds and background visuals influence our decisions. A 2007 study found that 73% of shoppers selected a German wine from a display featuring both German and French wines when German music played… while French wine was the choice 77% of the time when French music played. Similar studies have found that retailers can influence our purchasing decisions with smells and background images.
What to do: Be aware of your surroundings when deciding and, if possible, consider your decision under different conditions.
Mistake 5: We tend to seek out information that confirms our beliefs, but we ignore information that suggests we might be wrong. When we make a decision, we also make an emotional investment in that decision being correct. Once we’ve done that, our minds try to protect us emotionally by deflecting any evidence that the decision might be incorrect.
Example: Salespeople sometimes try to convince customers to place small deposits on large purchases. The salespeople know that once a deposit is made, customers’ minds will steer them away from any evidence that completing the purchase would be a mistake. Questioning the purchase would force the customer to admit that making the deposit was a mistake.
What to do: Before settling on a favorite and making a deposit, list your options on a sheet of paper, along with the pluses and minuses of each. Constantly entertain alternatives, including those that don’t square with your view.
Mistake 6: “We’ve always done it that way.” We often consider that a valid reason to continue doing something a certain way. Sometimes this makes sense — there isn’t time to reconsider every preference, habit and choice. Trouble is, we often assume that our previous choices must still be the right choices, rather than just the easy choices.
What to do: When you catch yourself about to do something in the same way that you’ve done it before, pause to reflect on whether it’s a good time for a reevaluation. Your priorities might have changed since you made the initial decision… or new and better options might have appeared.
