It’s not because of the decisions we make, the opportunities we consider or the investments we miss out on, but rather it’s due to the way we think. That’s because we’re subject to cognitive biases – the way our brains sneakily convince us to make decisions that aren’t always in our best interests.
Cognitive biases may convince us to spend more, save less, and feel more confident in our decisions than perhaps we should. And the scary thing is, for the most part, we’re powerless against them.
People tend to search for information that confirms their view of the world and ignore what doesn’t fit in. In an uncertain world we love to be right because it helps us make sense of things. We do this automatically, usually without realising, and partly because it’s easier to see where new pieces fit into the picture puzzle we are working on, rather than imagining a new picture.
For example, if we believe that a particular type of property, or a specific region, will make for good investing, then we tend to only seek out news and information that supports that position. One way to counter confirmation bias is to read things you’re going to disagree with, or look for reasons your strategies could be wrong, rather than right.
We have a tendency to use anchors or reference points to make decisions and evaluations, and sometimes these lead us astray.
Anchoring explains why you’ll pay $6 for an hour of parking after seeing $10 at a car park down the street. The first number you see, especially when it’s a price that comes up in negotiation, colours any that come after it. A high anchor influences you to spend more than you normally would.
Property marketers, real estate agents and car sale people use this principle all the time. They start with a high asking price and then you feel good when you extract a discount from them. This is because the initial price you set for a house or car or for a deal of any kind, tends to have ramifications right through in the process of coming to an agreement.
How are your investments performing? Are you happy with the results you’re getting? There’s a chance that even if they’re not doing so well, you may not even recognise it. In fact it’s been shown the poorest performers, in all arenas of life, are the least aware of their own incompetence. Lacking the capacity to realise how badly a task is performing is known as the Dunny-Kruger effect.
Many people view residential real estate positively, considering it an asset class through which they can grow their wealth, and they continue to view it in this light, even if their investments fail to prosper. In the face of lack of capital growth, prolonged vacancies or inflated expenses, they still continue to believe that their investment will turn the corner “one day”.
The problem is that when all signs point to a dud investment, it likely is one – but positivity bias can stand in the way of an investor taking action to rectify the situation. Overconfidence is a real risk for property investors – one of the best things they can do is admit what they don’t know.
Just as some investors can be overly positive, this is the the tendency to put more emphasis on negative experiences rather than positive ones. People with this bias feel that ‘bad is stronger than good’ and will perceive threats more than opportunities in a given situation.
Psychologists argue it’s an evolutionary adaptation – it’s better to mistake a rock for a bear than a bear for a rock. To keep our ancestors alive, Mother Nature evolved a brain that routinely tricked them into making three mistakes: overestimating threats, underestimating opportunities, and underestimating resources (for dealing with threats and fulfilling opportunities).
This is a great way to pass on genes, but a lousy way to promote quality of life or grow your wealth through property.
The bottom line
We all want to think we’re rational and biases are things that afflict other people. However our brains are designed with blind spots and one of their clever tricks is to confer on us the comforting delusion that we, personally, don’t have any biases. This is why so many of us are not only bad with money, but make he same mistakes over and over again. We’re effectively blind to our blindness.
Michael Yardney, Australian Property Investor, December 2014