How Cognitive Bias Determines Risk in Decisions

Posted by Devon Shryock

As an inexperienced climber in your right mind, you'd never think of taking on a high stakes mountain with only a GPS to guide you, right?

But let's say you decided to climb Mount Everest. It'll take weeks of preparation and a minimum of $70,000 for an experienced guide to lead your party to the summit and back. Let's pretend that you've managed to convince your spouse that this is #2 on your bucket-list, (#1 was actually winning that argument when by contrast he swears to prefer long, romantic walks on the beach.) Great! Now imagine that you've paid your fees and have spent seven weeks in the Himalayas preparing your body for the conditions you will encounter. At this point you are likely to feel heavily invested.

Then the unthinkable happens. Your highly experienced guide falls ill, unable to follow through. Another guide with comparatively less experience than the first can take his place, or you are free to reschedule another trip; it's up to you.

The option to reschedule means you'd lose all that time you've just put into preparing. What if you can't reschedule? What if neither the time nor opportunity ever come again? And while the other guide seems nice enough, the risks on Everest don't pull punches for nice guys. The anxiety you feel right about now seems unbearable.

This may be due to a loss aversion bias which in economics is closely linked to the sunk cost effect. Sunk Costs are past costs (in this case its primarily time and money) associated with an investment, that have already been incurred and cannot be recovered. Romantic walks on the beach with your Sweetheart aren't bad, but conquering Everest ...that's an experiential makeover.  

Loss aversion is natural to everyone from the stocks investor to the do-it-yourself home improver. Who hasn't held onto a stock they felt certain would make a comeback? Or how about the tile project begun four months ago for which the perfect but discontinued tile was bought at a bargain. Unfortunately, the unforeseen learning curve for cutting tile means there's no longer enough to complete the other 45% of the job and you can't find more of that tile anywhere. You're stuck between starting over, trying to match what you have with an alternative, or just hiring someone to take care of the whole enchilada. What do you do? 

  • Starting over means flushing all that time and effort you've already put in.
  • Finding a closely matching tile means it still won't be perfect. (After all, it's your creation.)
  • Hiring a professional to take over, start over, and get it done feels akin to giving up, or worse admitting failure.

It's certainly natural to feel an aversion to giving up on our personal investments of time, often courageous efforts, and carefully measured budget.

How to Outsmart Bias?

Click here to read now. 

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