This week, we'll take a step back from business models and dive into some psychology.
We love protecting our egos, but often this leads to suboptimal decisions.
For example, picture yourself as a professional soccer player. You're one of the world's greats. No one can stop you.
Frequently, opponents mock you and insult your abilities. Usually, you handle the onslaught well. But, one day, something snaps.
It's the big game, the championship against your rival team, what you've been working all your life for.
You know what's up ahead; your nemesis, a particularly nasty player, will be relentless. The insults, the yo-mama jokes, and whatever else it (not worthy of a gender*) dreams up will be directed at you for the next 90 minutes. Game on.
The game starts out well, but the other team scores a late goal in the 68th minute. This is where your team needs you the most. And your nemesis knows this.
It* starts taunting you and calling you names. Right in your ear. You tell the referee but she can't do anything about it if she can't hear it. Finally you snap.
You sock it* right in the mouth. The ref sees. You get a red card and cost your team the game. Season over.
It's a probable story but it could've been prevented.
The Decision
Right before you snap, there's a decision you have to make. Either you sock it* and feel really good in the short term or you hold off and possibly feel really good in the long term after winning the championship #delayedgratification
But remember, another element was at play. You were down 1-0 late in the game. Had you been winning, you likely wouldn't have paid any attention to the taunts. Your brain was telling you that there was no guarantee you'd be happy in the long term and if you didn't get the satisfaction of punching it* in the face, it'd be a lose-lose situation.
In this scenario you protected your ego and in doing so, made a suboptimal decision.
Let's continue breaking it down.
There is a psychological bias called confirmation bias. Everyone, and I mean everyone (definitely me), is prone to it.
Confirmation bias is the tendency to seek out and interpret information in light of your existing beliefs.
What this means is that we typically don't let facts dictate our beliefs, but our beliefs shape how we see the facts.
Take this for example. Let's say you get called into jury duty and you get on a case.
The case is between a young couple and the woman is accusing the man of sexual assault. It's a touchy subject.
If you are a woman who has faced similar awful things, and you believe, somewhat understandably, that all men are chauvinist pigs, you probably will see the facts of the case through that lens. It's impossible not to. But, undoubtedly, your decision will be biased.
On the other hand, if you are a man who was wrongly accused of sexual assault, you'll be biased towards the man's point of view.
In both cases, it would be nearly impossible to remain objective. And it's kind of the same way in regular life. We all have life experiences and beliefs we have accumulated over the years. As time goes on, typically, we become more attached to these beliefs, until they are a part of our identity.
Ever wonder why people fight about politics so much? It's because their identities are wrapped up in it.
But this becomes dangerous, especially when we are trying to make optimal decisions in other areas of our lives.
And it's the same with investing.
You really love a particular stock. Your neighbor told you about it and you did a fair amount of research. So you buy a ton. However, things change. Management starts selling all of their shares, the company takes on too much debt and cash flow starts decreasing.
But you've already made your mind up. You have a belief and now, in the grip of confirmation bias, you'll likely interpret the facts to put yourself at ease.
Management selling shares? Probably need to buy a house in Maui.
Taking on debt? Take advantage of the huge growth opportunity.
Decreasing cash? Management is re-investing back into the business.
Here's the thing. Your assumptions could be right. Or not. You have to be aware your belief that this is a good company could be distorting your objectivity.
So what are we frail humans to do?
Well, first off, you have to ask yourself the question, "Would I rather be happy or right?"
That is, happy in the short term versus right in the long term.
It's just like you on the soccer field. Right before punching it*, you had a decision to make and you picked "happy" rather than "right." You protected your ego and therefore made a poor decision.
If that stock you love starts decreasing after the recent developments, would you rather defend your beliefs or dig in and see if you were wrong? Defending your beliefs is less cognitive work and more ego protection in the short term which means more happiness. But it could also mean less money in your brokerage account.
So to supplement the happy vs. right question, envision the worst case scenario if you decide to protect your ego. On the soccer field, it's getting a red card and losing the championship. In investing, it's losing all of your money on that investment.
Envisioning the worst case scenario allows us to more readily delay gratification. If we can see we're headed straight off a cliff, we might be more apt to change course. It makes protecting our egos seem less important.
Another way to handle this problem is by creating a negative hypothesis, where you focus on disproving your beliefs. For instance, going back to that stock example, you'd try to prove that your beloved stock is a bad investment. This tricks your brain out of confirmation bias because you have a whole new mission. Author Brian Tracy in his book, Get Smart, talks about the notion of making reverse hypotheses,
"This is exactly the opposite of what most people do. They come up with an idea, and then they seek corroboration and proof that their idea is a good one. They practice 'confirmation bias.' They only look for confirmation of the validity of the idea, and they simultaneously reject all input or information that is inconsistent with what they have already decided to believe.
Create a negative or reverse hypothesis. This is the opposite of your initial theory. For example, you are Isaac Newton, and the idea of gravity has just occurred to you. Your initial hypothesis would be that "things fall down." You then attempt to prove the opposite - "things fall up."
If you cannot prove the reverse or negative hypothesis of your idea, you can then conclude that your hypothesis is correct."
To End
While we all struggle with protecting our ego and falling prey to confirmation bias, it doesn't mean we should give up and keep making suboptimal decisions.
Delay gratification by thinking of the worst possible outcome of your decision and then try a reverse hypothesis.
It's not easy, but it's a step in the right direction for making better decisions.