Avoiding Your Cognitive Bias Trap

Posted by Devon Shryock

What matters more?

Being under the influence of loss aversion bias can make us feel rooted to the spot, unable to cut our losses or find a way to salvage what we can in order to move forward. But the instinct to make the best of our investments is natural survival. However, if we know our stress tolerances well and have the fortitude to admit them then this instinct serves us well.

Let's say we purchase one car over the other because it comes with a better warranty and more affordable fees for service and maintenance. The sunk cost/loss aversion we dodge in this case by choosing a car with warranty and maintenance in mind, points to the higher value placed on peace of mind. The hidden cost of not honoring our long-term over short term preferences might otherwise mean potentially expensive repairs, not to mention the headache and time used if the car turns out to have problems within a year. We'd rather pay a bit more now for a worry free half-decade. 

Another person, may feel greater aversion to the up-front cost of purchasing a car; so they go with a less expensive one that has a cash back benefit even though its warranty doesn't cover as much. Since its a new car they'd rather gamble that it will perform well for a long time before anything goes wrong. "Besides," they mutter under their breath, "my friend is a mechanic." (oh-oh!)

However, if things don't quite work out the way they had hoped, they may still be reluctant to give up the car for a multitude of reasons. So they keep putting money into it hoping that the last expenditure will do the trick. The ruling value in this case, whether by choice or by default, is the money already sunk into the car...or maybe its just a really hot car and giving it up means giving up the dream. That may be where loss aversion rises for this person. So each of us has to decide which is the deal breaker for us, and then honor that. That is optimizing over satisficing.

Satisficing isn't Optimizing

Still, it can be confusing when everything matters. The optimum combination of affordable upfront investment cost plus the assurance of lasting peace of mind is almost always out there... somewhere. Avoid satisficing! That means continue to look beyond (rather than only up-to) the point where you find merely acceptable solutions. The key is knowing where your personal loss aversion rises, and to take steps to protect what you value most. It's best to always assume there is a hidden cost to every decision we make, beyond the exchange of actual money. A wise person is cognizant of what that is for him or her and assigns a clear value to protecting against it.

So if you bravely walk the road less traveled by while others continue throwing good money after a poorly performing decision, then you might decide to let a professional redo the tile in the basement bath even though it means investing more. Or you might just decide to reschedule that Everest trip rather than risk personal safety with an unknown leader. Of course, psychologists have shown that human beings tend to be overly confident in their decisions -which also has a name, predictably the overconfidence bias. Remember Scott Fischer from the 1996 Everest tragedy? He once said, "We've got the big E completely figure out, we've go it totally wired."

But that's another conversation...

Continued from How Cognitive Bias Determines Risk

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Apr 23, 2016
IRKSKq13AjsB said:
I was so confused about what to buy, but this makes it undaestendablr.
Apr 25, 2016
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