The Psychology of Investing: Biases, Shortcuts and Blind Spots — Part 1
The human brain is a powerful piece of biological machinery. Through a complex network of white and gray matter, it gathers data from our senses and physical body then processes it and responds accordingly. The unconscious part of the brain alone processes 11 million bits of information per second. While an incredible number to think about, this figure has not changed much in thousands of years of human evolution. Today, we have a very different set of decisions to make than our ancestors, as well as exponentially more information at our disposal.
According to the International Data Corporation (IDC), the world’s collective data is projected to increase from 33 zettabytes to 175 zettabytes by 2025. This equates to an annualized growth rate of 61 percent. In addition, IDC estimates that the average person will have up to 5,000 digital interactions by 2025. This would be an increase from the 2018 interactions of approximately 800 interactions for the average person. This cognitive overload is growing tremendously, and our brains are increasingly unable to adequately process the information we are being exposed to. So what happens when human evolution has yet to catch up with modern technology? We make shortcuts.
The brain strives to solve problems and make decisions as efficiently and quickly as possible. To accomplish this, the mind makes mental shortcuts known as heuristics. Heuristics can be helpful in many situations because they reduce the time and effort needed to make decisions. However, they can also lead to blind spots, also known as cognitive biases.
Let’s take a step back. Even before the increased cognitive load from mobile devices and digitized life, the human brain received an enormous amount of information to process. In the 1950s, Nobel Prize recipient psychologist Herbert Simon put forth that the human brain does not always make rational choices and that human decision-making is subject to cognitive limitations. Inspired by Simon’s work, psychologists Daniel Kahneman and Amos Tversky coined the term ‘cognitive biases’ in the 1970s and researched how they affect judgment and decision-making.
Cognitive biases are the tendency to deviate from rational, logical-based thinking. Of course, making completely rational decisions is not as easy as it sounds. Even if people had access to 100% of the information needed for deciding, it would be logistically impossible to take the time to rationally analyze every piece of quantitative and qualitative data. Instead, the brain takes the path of least resistance, making decisions based on things like past experiences and personal beliefs. This results in some major blind spots.
Investors are faced with myriad options when making investment decisions, from asset classes and transaction timing to whom they should trust with their hard-earned capital. It is human nature to find the most direct way to arrive at those decisions, but one must keep in mind that routes may have different roadblocks or traffic patterns than they did yesterday — or, unbeknownst to them, an easier alternative route might already exist.
Stay tuned for Part 2 of this series, where we will take a look at a few of the common blind spots in investing — and how to overcome them.
For more information on passive investing in commercial real estate, please check out our free eBook — More Doors, More Profits — by clicking here.
Mo Bina
Managing Principal
High-Rise Capital
Website: https://www.high-risecapital.com/
LinkedIn: https://www.linkedin.com/in/mohrc/
