334: Cognitive Bias in Life and Investing

Buck: Welcome back to the show everyone. Today, my guest on Wealth Formula Podcast is Gleb Tsipursky. He’s CEO of the Future of Work Consultancy, which is a disaster avoidance expertise group which specializes in helping analytical leaders adopt a hybrid first model instead of incrementally improving on the traditional office centric model. He’s also the author of multiple best selling books. Today we’re going to talk about issues related to one of those books, which is The Blind Spots between us. Welcome to Wealth Formula Podcast.

Gleb: Thank you so much for inviting me, Buck. It’s a pleasure to be on.

Buck: So this is actually a big topic, which is cognitive bias. And I think in order to get an idea of the importance of this, let’s start out and define what exactly cognitive bias is.

Gleb: Sure. So cognitive biases are the mental errors in our minds that cause us to make bad financial decisions and all other sorts of decisions in our professional and personal life. And why do we have these errors in our minds? Well, the thing is, our minds, our emotions, our gut intuitions are not set up for the modern environment. They’re set up for the ancestral environment. That’s why it’s very tempting for us to do things like, let’s say, sell high and buy low. We want to buy low and sell high. But most investors end up doing the opposite. They buy high and sell low. And there are a lot of other wealth issues that financial matters and professional matters and life matters that people make mistakes about because we’re not wired for the modern environment. Again, our intuitions, our emotions, our gut reactions are really wired for that ancestral environment. When we lived in small tribes of 50 people to 150 people and we had to survive based on our fight and flight impulses were wired. That’s what our intuitions tell us to do. And that’s why Warren Buffett makes a lot of money betting against retail investors because he knows about these cognitive biases and he has studied these cognitive biases and he knows how to go against people’s instincts and intuitions. So this is why you should be learning about these cognitive biases, because a lot of people don’t know about them. And there are so many, whether in investments, whether in ordinary financial decision making, buying a house, whether in your job. You’re going to make a lot of mistakes if you don’t know about these blind spots.

Buck: So I want to drill down a little bit on this idea that these cognitive biases are in a way, I guess what you’re saying is that they’re essentially hardwired from the way we evolved through time in small villages, hunter gatherers, looking for food. Give me some example of why would that kind of hardwiring lead to somebody buying high and selling low?

Gleb: Happy to. So let’s think about a very fundamental aspect of what our impulses were about. The fight or flight response. What does that mean? Well, in the survival environment, it was very important for us to flee or fight. In a survival situation. When we heard a noise, it was important for us to not spend a lot of time thinking about, well, what’s going on with that noise? Might it be a fabric of tiger? Might it be a snake? Instead, what was very important was for our emotions to wind us up for action, for us to have a bias toward action, whether that’s fighting or fleeing. So our ancestors were wired to jump 100 shadows rather than to miss a sabre to tiger or a snake or an opposing tribal member attacking us. Now, think about that. So that means that we are wired to make very quick judgments based on very little information that’s coming at us immediately. So what’s happening with why do people sell low? Why do people buy high? Well, when the market moves and people start paying attention to all the market has moved, that means that it’s already moved. And that means that the market has already moved and people have phone calls, you’re missing out based on very impulsive, intuitive information. And they forget that large institutional investors and henchfan managers and so on, they know about these cognitive biases. Warren Buffett knows about these cognitive biases and they get their money in before the market moves or they make the move of the market. So you are going to be ending up buying after the institutional investors have already made the market move based on your instincts and impulses, if you just react as how humans ordinarily react.

Buck: So I guess the parallel I’m thinking about, and correct if I’m wrong, is selling low would be like running away from a saber tooth tiger. There’s evidence of danger and so you need to make action and see you sell. So that’s a fear thing. And then on the flip side, you might have a situation where there is an opportunity to gather up as much food as possible in an environment because there is plenty and you see everybody else has it and you want to get your share, so you’re buying it.

Gleb: That’s the attack mode. That’s the fight response. So you want to fight for your share.

Buck: Right. And that leads to the FOMO aspect. Interesting. I want to talk a little bit more about technology as it plays a role in blinding humans to truth tell me about because obviously these worlds that we’re talking about are paradoxical, right? The responses that we had that were hardwired and sometimes don’t work in a technology with the type of technology in the world that we have. And also beyond that, technology may exist in part to take advantage of our hard wiring.

Gleb: Absolutely. Let’s take a look at Robinhood as an example. The app, that app has very popular and people it’s very popular because it has gamified investing. And gamification is very much technique that uses our intuitions, our cognitive biases to take advantage of us. So it causes robinhood gets people to keep buying, keep trading or selling, whatever it is, keep buying, keep trading, because it gives people a reward, incentive, praise. You get those balloons, you get those celebrations when that happens and you see your stock going up, going down. So it induces people to do a lot of day trading. And we know from extensive research that day trading is one of the worst things you can be doing. Unless you’re a supremely sophisticated investor, which unless you are a hedge fund manager or you’re kind of involved in that world, you are unlikely to be that sophisticated. So day trading is going to be pretty bad for many people and it will be bad for me, it will be bad for anyone who is not very deeply involved in the situation. And there are apps, technology like you’re talking about bugs that make people very tempted intuitively to engage in us because it’s gamified and it rewards, people feel good about it and they see their stocks going up, down, kind of like sports or they’re cheering them on, right? And so people feel that they can make money and then they end up losing a lot of money. And Robin Hood of course makes a lot of money on you trading. So it’s source of income comes from your trading, so it’s incentivizing you to trade and it’s manipulating you to trade using those intuitions, using those instincts, using our beliefs and our feelings and our gut emotions. Any person who wants to make good decisions about their finances, whether it’s in trading, financial investments or in all sorts of other areas, needs to learn very fundamentally that their gut intuitions are going to be leading them astray very often. And that there are sophisticated people who learn about these cognitive biases and who are going to be out to screw you and take advantage of it. Because that money has to come from somewhere, someone has to be left holding the bag and unfortunately it’s retail investors who are going to be left holding the bag overwhelmingly. And so that is what’s going to be happening. If you don’t know about these blind spots, if you don’t know about these cognitive biases, you need to learn that your intuitions are going to be leading your strength and you can’t let your intuitions lead you straight. You need to learn where they’re going to be leading your strain. And so those are kind of some of the basis for these cognitive biases. And there’s a whole number of specific cognitive biases that we need to learn about and I can happy to share about specific ones. Great, so that’s kind of the technology question. As an example of Robin Hood and so on, let’s talk about some of the cognitive biases now you have to learn about which cognitive biases are going to be most meaningful to you. One of the biggest ones in wealth management is called sunken costs. So sunken costs, that means that when you make an investment and the investment is not going well, it’s very tempting for us to throw in good money after bad. Sometimes that might mean doubling down on your investment, sometimes that might mean holding on to the investment even though the situation is clearly deteriorating. But why do people hold on to that investment when it’s not a good idea and when others are fundamental, it’s not a good idea. When they’re looking at market conditions and they’re seeing that bitcoin is going down or crypto went or whatever it is, bitcoin might be going up. I’m not necessarily criticizing bitcoin. I’m giving an example. If you think that bitcoin is going to go down, there’s still a bunch of people who will just hodl and keep holding on because they feel that, well, if I sell bitcoin now, I’ll have lost money and I’ll be wrong. I don’t want to be wrong. And so that’s the intuition. So that’s when you’re feeling that when you’re feeling you don’t want to be wrong, and when you’re feeling that you don’t want to lose money, that’s your gut reactions causing you to make some decisions that are going to be pretty harmful. And that’s called something costs. So you want to back away from that. You want to say, okay, let’s stop. I have these emotions, but regardless of whether I’ll be wrong or whether I’ll have fixed in the loss when I made the sale, what I want to do is ignore the past, set aside the past. The past happened. I need to let it go, and I need to see the future, what’s the future going to be? Looking at market signals, looking at what’s the situation going to be? Is my investment going to go up? Is it going to go down? If you think it’s going to realistically keep going down, but you don’t want to sell it because you don’t want to be wrong, that is wrong. That is a problem. If it’s going to keep going down, unless you have some very specific tax reasons, you should really sell that investment. If you think it has a reducing chance of going up, you might want to hold on to it. But if you think it’s going to go down, and most likely it’s going to go down, that’s when you should sell it. And you certainly should not be investing more money into something that is going to go wrong. So that’s something costs. And that’s a big problem for us. And it comes from us not wanting to be wrong, not wanting to face up to that mistake that we’ve made.

Buck: Sure. That makes sense. How about tell us more cognitive biases? Another huge one with wealth management is called loss aversion. So lost aversion, I would say this is probably the biggest of all the cognitive devices that harms wealth management. I start with sunken costs because it’s specifically very relevant to trading. But lost aversion is just in general for wealth management. And so this is what it’s about. So imagine that you gained $100. Suddenly there’s a bank mistake in your favor, and suddenly somehow you get $100. And think about how it feels, right? It feels good. You get $100. That’s nice. Good. Now imagine different situation. Imagine that you just found out you lost $100. Something broke, you need to replace it. It’s a problem. You got some kind of fine. You lost $100. How does that feel? Now, when you think about it, and when you actually look at the research, how people feel about it, you see that people overwhelmingly care about losses more than they care about games. A lot more. Like, really a lot more. So I’ll give you another example. When you ask people, hey, here, I’ll give you two options. One option. I’ll give you $45. So right now, I’m giving you $45 in cash. So here. You can keep those $45. You have those $45 here. Now you can give those back to me. And what I’ll offer you is a flip of a coin. If the coin is sales, you’ll get $100. If it’s heads, I keep your $45. So what do you do? What overwhelmingly 80% to 90% of people do in those situation is keep $45. They want that $45. No. It feels comfortable. It feels good, right? They don’t want to lose money on the coin flip. But think about the coin flip. The coin flip is a 50% chance of getting $100. That’s $50. You are giving up $50 for $45. Now. That is always an investment you should be making. If you get $45, you know the likely return on investment the ROI is $50. That is, if you really analyze it, it’s a no brainer, right? You should be making that decision. But the large majority of people don’t. Why is that? Well, because they don’t want to give up that $45. They don’t want to lose. They’re worried about that chance. But think about this. Our life. When you think about the way that we live our life, it’s made up of 10,000 coin flips, right? So 100,000 point flips 100,000 of those opportunities. When you have 100,000 of those opportunities, that’s $4.5 million. If you decide to keep the $45 or that’s 5 million. Now, that’s probably around what you’ll make in your lifetime. 4.5 million on average, right? Some people make more some people make less but you make 4.5 million. Or you make 5 million. Now, when you think when you ask the average person, they much rather make the 5 million, but the result of each of our individual interactions when we meet each of these individual decisions, each of these coin flips, we are very tempted to take the $45 because we don’t want to lose. We don’t want to take the wise and risk that we should. And so, as a result, we lose a lot of money. That’s 10% of our money. Think about losing 10% of your salary per year. That’s a lot of money because you’re not taking the right risks. And so that’s called loss, Aversion. And so loss. Aversion hits us in our investments. It hits us in our salaries and our jobs, in our professional decision making us in our lives and the kind of risks we take or don’t take in our lives. Lost aversion is a fundamental cognitive bias. It causes a lot of problems throughout our lives.

Buck: We can shift a little bit away from finance because they think these topics are relevant to life in general, right? Absolutely. Loss aversion. Is that why people don’t break up with girlfriends?

Gleb: That’s more sunk cost actually, when you already invested a lot of your emotions into a relationship, you don’t want to lose those emotions. And that all the time and labor you invested into the relationship and you’re like, oh, I won’t find somebody else, I don’t want to lose what I had. And people just keep throwing good emotions. So here there’s a very important concept that we want to think about called opportunity costs. So opportunity costs is the concept that we are not seeing what the resources are that we could be using for all other sorts of opportunities. So in relationships, right? So we’re thinking we’re in a relationship that we’re not very happy about and we don’t think it’s really going to go anywhere, but we’re kind of like whatever, it’s fine. I don’t want to take the effort to find somebody else. But we don’t think about what are the opportunities that we’re losing out every day that we’re stuck in a bad relationship. So that is something that we’re not thinking about, the opportunity costs of being stuck in that relationship. And so the opportunity costs build up over time. It’s kind of like compounding interest. They compound. So we could have found something good and we could have been investing resources into a much better relationship or a much better investment or a much better friendship or maybe should have moved to a different city and be investing resources into a different city or something like that. So all of these sorts of things are investments that we’re not thinking about because we’re missing out on the opportunity costs. We’re blind to them. And that is a cognitive bias called the emission bias. So mission bias, when you think about an action, action is called commission. You commit an action, you do something. A mission bias is not doing something. So what? Our intuition tells us that not doing something is not an action. Our intuition tells us that not doing something is not relevant or important, but we should only be thinking about actions. And so that’s why we miss all of these opportunities costs. We miss all of these things that we could be doing. So the mission bias is the failure to realize that not acting is actually a choice. We’re making a choice by not acting, we’re not taking action and we are really losing out on resources that we could have been gaining all of this time by not acting. So that’s the mission bias and that causes serious problems for us with the opportunity costs.

Buck: I know you have thought about the modern news cycle and I think you’ve described as a post truth world. How do cognitive biases relate to? That our new reality in terms of media?

Gleb: Yeah, this is a very powerful dynamic. So one of our biggest cognitive biases relevant to the new world is called the mere exposure effect. So mirror exposure effect. So what’s that about? That is the fact that when we get exposed to information, we become more comfortable with information. When we become exposed on social media, we’re exposed to a lot of information. And whenever we hear something, the first time we hear something, it’s more start, it’s more new, it’s more novel. We pay more attention to it where we examine it more. But the more something is repeated, the more comfortable we get with it. So it’s the meter exposure effect. And so when you have misinformation, just like when you have a fact, when you’re exposed to a fact, you become more comfortable over time. And when you become exposed to a lie, to a falsehood, you become more comfortable with it over time. It’s less startling, it’s less novel. It seems like, oh, yeah, I heard that before. Yeah, that’s fine. It becomes more and more fun and more and more accepted and more and more part of your background context. And what happens in the end after you’ve heard about it several times, is you get to what’s called the illusion of truth effect. So the illusion of truth, when it’s been called truthiness, when you have something that is a falsehood, but you have an illusion that it’s actually true, that it’s actually real because you’ve heard about it a bunch of times from whatever sources. It doesn’t have to be sources you trust. It can be just someone posting something on Facebook or Twitter or whatever else you follow or some news channel that is not very reliable saying that. So you have this miraculous effect that comes from that comfort. So think about all these things. By the way, go back to the savannah environment. In the savannah environment, when you’re exposed to a stimulus, and when that stimulus doesn’t result in a threat to you immediately, then it’s more like, okay, it becomes part of your background and you’re not as worried about it, and it’s like, okay, that’s fine. That’s a stimulus I don’t have to pay attention to anymore. It’s just there. It’s just whatever. And so when you become exposed to that sort of stimulus in the modern world, over time, it becomes comfortable and becomes something that you accept as part of your background context.

Buck: So conspiracy theories would be an example of this, right? I mean, sometimes I hear some pretty crazy ideas, and they’re coming out of the mouth of pretty smart people, and I wonder how that’s possible. And this is, I guess, potentially how you explain that is that you hear it so many times, you may be hearing it for the first time, but this other person who believes it has heard it many times from many sources, and therefore it becomes something that could be real.

Gleb: Yeah, you’re exactly right. So when that person heard about it from a number of sources, it doesn’t have to be credible sources, it can just be a number of times. So that means the problem with social media is that it’s not the credibility of the source that’s important, it’s how many times you’ve been exposed to it that’s important. So this is the crucial thing. And this is what people don’t get about social media. What the large majority of us don’t pay attention to is the source of the information. We just our intuition or gut reaction, our emotions, our cognitive biases call us just to pay attention to the amount of times that we’ve been exposed to. So some organization pays for an advertising campaign targeted to you, or if they’re using Facebook or Twitter algorithm, effectively they know how to manipulate the algorithm. And you get exposed to that information because whether because of advertising or manipulation of algorithm, then you will start to believe the information that you’re exposed to, regardless of whether it’s true or not, just because of this new exposure effect. Maybe not you, maybe you are the individual who is very skeptical about everything they see, but then your friends do and your community does and everyone else does. That is how, unfortunately, social media has really undermined our democracy. And I talk about that in the book. The blind spots between us as well. I was talking about all the financial education and personal decision making, how we really get into this situation where the social media landscape is really fundamentally undermining our information, our knowledge based on the information that we’re being exposed to. And that’s not to mention that falsehoods travel on social media faster and further than the truth. And we have extensive research to show this, that they can travel up to ten times as fast and as far as truthful information. Now why is this? Well, because what travels well on social media is information that causes people to feel angry. That causes people to feel angry. So anger is the fundamental, the biggest emotion that causes people to share something on social media. Regarding politics, I mean, there’s cuteness emotions where people share cat videos, right? But regarding politics, regarding information about a public policy, people don’t share something out of just, oh, you know, I’ve been thinking about this and this seems like a relevant thing to share. That is not something that really leads to sharing, that leads to reflection. And people who are calm about something, if it’s something like a nuanced perspective, people are much less likely to share it than if it’s a strong statement that inspires strong emotions, especially around anger. So that’s fight response. So people share these things and what tends to inspire anger? Things that are specifically written in a way designed to inspire anger. And that tends to be overwhelmingly misinformation because misinformation can be written. First of all, it can have an image. Images fundamentally really induce people to share. Images are really important. People get a lot of their information about a story from an image and from the headline. So a false story piece of misinformation can have as misleading and stimulating an image as it wants and as misleading and stimulating anger inducing, stimulating, I mean stimulating emotions, anger inducing headline as it wants. And of course BS in the body of the article or whatever it is, video and so on. And because of its ability to optimize the piece of misinformation to be as anger inducing as possible, then of of course, course it will be shared more than a truthful piece of information because you know what, the world is actually pretty messy. It’s pretty complex. Issues are very rarely black and white. There are always going to be some shades of gray. So an actual truthful, accurate article is going to be much more shades of gray with some nuance.

Buck: The truth is boring. Often the truth is boring. And boring doesn’t sell, it’s not interesting, it’s not shareable. Nobody cares. If we know how powerful these cognitive biases are, is there a way to harness them to improve society, not just pull us apart?

Gleb: Absolutely. So there is a science in practice, which I described in the book, the blind spots between us call behavioral science and especially this dynamic called choice architecture. So choice architecture is how we shape society for the good. You might have heard of this as nudging also. So nudging people in the right direction. And one of the big triumphs of choice architecture is default investment. So if you, for example, if you’re working for a large corporation and they set up a default investment that automatically, without you doing anything, puts away 10% of your savings of your salary and matches it with 10%, the top match of the corporation is going to be 10%. That’s going to be a choice architecture development. It’s been around since the last couple of decades, I believe. And specifically, companies have been setting up these defaults because of the findings on cognitive biases and short choice architecture that people tend to stick with whatever the default is. And so previously to these findings, companies have been asking people to choose, do you want to put 10% of your salary away into the deposit for your savings? And many people would say, no, I don’t. I want to keep all of my salary. And they’re like, fine, you keep your salary. But as a result, people vastly under safe retirement and they’re going to be in a very bad situation when they’re 65 and ready to retire. And so companies have been switching to automatically enroll people and have people have the option. Instead of having the option to opt in, people have the option to opt out, right? And when people have the option to opt out, they’re like, well, this seems reasonable. Fine. I’m not going to opt out. And so by this default, people have been making much better choices about their finances and this has been going on large corporations, it’s been increasingly going on in government and the army has been increasingly instituting these defaults. So right now that our military is going to be in a much better situation when they retire. So that’s been a real triumph of choice architecture, of making good decisions, of helping people make good financial decisions. So that’s one example and there are a number of other examples where when you have choice architecture and shape people’s choices to give them the right default choices, the right options that are going to be best for them in the end. But if they could get rid of their cognitive biases and self reflect, the large majority would prefer whatever the default choices. And if they don’t prefer, they can opt out of it. So that is something that you can do on a society wide level. Now, on an individual level, what you can do is read my book, The Blind Spots Between US and just learn about these cognitive biases. Because there are so many things, like I told you about the $45 versus the $50, right? That is something you can do. That is something where you can catch yourself and say, well, this seems risky and I don’t want to take this risk. But really, let’s think about it. What if I don’t think about this risk as a one time thing? What if I think about it as a series of things? So if I had a series of choices of $45 versus 50% chance of getting $100, what would I choose? Do I want to get 4.5 million over my life or do I want to get 5 million? The vast majority of us would want to get 5 million. So you want to, instead of treating this as a one off choice, treat it as a series of choices. And when you treat it as a series of choices, you’re much better, more likely to make the right decision. And that’s just one of many tricks that you can use to address these cognitive biases once you know it. So there’s society wide things we can do and plenty of individual things that we as individuals can do to address these cognitive biases within us.

Buck: A lot of the solutions that you suggested on the society side, they involve some sort of corporate intervention and I think beyond, I guess some people would have some objections to that in the first place. But I guess one, you have to start with the default one way or another. But there’s an entirely different world that’s coming up through distributed ledgers and stuff where there really is no there’s no one in charge. How does that change the ante there? Because that seems like a train that’s kind of something that’s very difficult to control.

Gleb: I think that’s where you talk about the structure. So right now, let’s say Ethereum is going through a splitting of fork, right? The people who manage Ethereum and others, they can create certain structures, they can create certain defaults that are going to be inducing people to behave in a way that’s going to be beneficial as opposed to not beneficial, right. Proof and so on. What kind of environmental impact will you have? Right? All of these sorts of things. You can think about it going down the road and you can think about how can you shape people’s choices to do things that are going to be beneficial for people as opposed to not beneficial for people and where people would actually want these outcomes. There are lots of things that we can be thinking about and the government is trying to regulate certain things. And I’m not saying they’re doing the right thing or the wrong thing. I’ve not investigated. But that is where the government can have a role. It’s necessarily the distributed ledgers. If they’re not constructed in a good way, the government can come in and say, well, maybe we want to limit certain things. Like I think recently, if I remember correctly, the government banned some cryptocurrency which prevent us being able to see where one crypto transfer comes from and where it ends to prevent money laundering and other sorts of things like this. Perhaps that’s a good thing where we don’t want this sort of level of anonymity, right, where that’s going to scramble and we can’t see the final outcome that North Koreans have been using this to hack. So these are the kinds of things where we can make certain interventions and to have outcomes that are going to address some of the cognitive biases that we have and that are inbuilt into our systems and in a positive way, like corporations and government pension funds have been really using to help us all have a better retirement plan going forward. Which is great. Like you want people to be in a better financial situation going forward, right? So that’s the kind of things that you want to be thinking about.

Buck: So the book is The Blindspots Between Us. Gleb Tsipursky, where can we find this book? I presume, everywhere, Amazon, the usual outlets.

Gleb: Yes.

Buck: Is there an Audible?

Gleb: No, there’s not an Audible for this book, but there’s for my other books like Never Go With Your Gut, there are Audibles. So if you want to check that out, that’s going to be more business focused. The Blindspots Between Us is focused on professional and personal life.

Buck: Is there anywhere else we can learn more about what you’re doing?

Gleb: Yes. Go to disasteravoidanceexperts.com. That’s my website. There are blogs, videos, podcasts and addressing these cognitive biases. So again, disasteravoidanceexperts.com and especially check out the assessment on dangerous judgment errors. So if you want to figure out which of these dangerous judgment errors, which of these cognitive biases are most prevalent and relevant to you. Go to disasteravoidanceexperts.com subscribe and take the free assessment on dangerous judgment errors. disasteravoidanceexperts.com subscribe.

Buck: Fantastic. This is really interesting stuff. Gleb very helpful. Thank you very much for being on Wealth Formula podcast. We’d love to have you back sometime.

Gleb: Thank you so much, Buck. I really appreciate the invitation.

Buck: We’ll be right back.