by Rolf Dobelli
Suppose that, on this highway, a traffic jam develops 10 percent of the time. The probability that I will get stuck in a jam on a particular day is not greater than the probability that one will occur. However, the likelihood that I will get stuck at a certain point in my journey is greater than 10 percent. The reason: Because I can only crawl forward when in a traffic jam, I spend a disproportionate amount of time in this state. In addition, if the traffic is zooming along, the prospect never crosses my mind. But the moment it arises and I am stuck, I notice it.
The same applies to the lines at bank counters or traffic lights: Let’s say the route between point A and point B has ten traffic lights. On average, one out of the ten will always be red, and the others green. However, you may spend more than 10 percent of your total travel time waiting at a red light. If this doesn’t seem right, imagine that you are traveling at near the speed of light. In this case, you would spend 99.99 percent (not 10 percent) of your total journey time waiting and cursing in front of red traffic lights.
Whenever we complain about bad luck, we must be wary of the so-called self-selection bias. My male friends often gripe about there being too few women in their companies, and my female friends groan that theirs have too few men. This has nothing to do with bad luck: The grumblers form part of the sample. The probability is high that a man will work in a mostly male industry. Ditto for women. On a grander scale: If you live in a country with a large proportion of men or women (such as China or Russia, respectively), you are likely to form part of the bigger group and accordingly feel hard done by. In elections, it is most probable that you will choose the largest party. In voting, it is most likely that your vote corresponds with the winning majority.
The self-selection bias is pervasive. Marketers sometimes stumble into the trap in this way: To analyze how much customers value their newsletter, they send out a questionnaire. Unfortunately, this reaches only one group: current subscribers who are clearly satisfied, have time to respond, and have not canceled their subscriptions. The others make up no part of the sample. Result: The poll is worthless.
Not too long ago, a rather maudlin friend remarked that it bordered on the miraculous that he—yes, he!—ever existed. A classic victim of the self-selection bias. Only someone who is alive can make such an observation. Nonentities generally don’t consider their nonexistence for too long. And yet precisely the same delusion forms the basis of at least a dozen philosophers’ books, as they marvel year in, year out at the development of language. I’m quite sympathetic to their amazement, but it is simply not justified. If language did not exist, philosophers could not revere it at all—in fact, there would be no philosophers. The miracle of language is tangible only in the environment in which it exists.
Particularly amusing is this recent telephone survey: A company wanted to find out, on average, how many phones (landline and cell) each household owned. When the results were tallied, the firm was amazed that not a single household claimed to have no phone. What a masterpiece.
48
Why Experience Can Damage Your Judgment
Association Bias
Kevin has presented his division’s results to the company’s board on three occasions. Each time, things have gone perfectly. And, each time, he has worn his green polka-dot boxer shorts. It’s official, he thinks: These are my lucky underpants.
The girl in the jewelry store was so stunning that Kevin couldn’t help buying the $10,000 engagement ring she showed him. Ten thousand bucks was way over his budget (especially for a second marriage), but for some reason he associated the ring with her and imagined his future wife would be just as dazzling.
Each year, Kevin goes to the doctor for a checkup. Generally, he is told that, for a man of forty-four, he is still in pretty good shape. Only twice has he left the practice with worrying news. Once the problem was his appendix, which was promptly removed. The other time it was a swollen prostate, which, upon further inspection, turned out to be a simple inflammation rather than cancer. Of course, on both occasions, Kevin was beside himself with worry when leaving the clinic—and coincidentally, both days were extremely hot. Since then, he has always felt uncomfortable on very warm days. If the temperature starts to heat up around one of his checkups, he cancels right away.
Our brain is a connection machine. This is quite practical: If we eat an unknown fruit and feel sick afterward, we avoid it in future, labeling the plant poisonous or at least unpalatable. This is how knowledge comes to be. However, this method also creates false knowledge. Russian scientist Ivan Pavlov was the first to conduct research into this phenomenon. His original goal was to measure salivation in dogs. He used a bell to call the dogs to eat, but soon the ringing sound was enough to make the dogs salivate. The animals’ brains linked two functionally unrelated things—the ringing of a bell and the production of saliva.
Pavlov’s method works equally well with humans. Advertising creates a link between products and emotions. For this reason, you will never see Coke alongside a frowning face or a wrinkly body. Coke people are young, beautiful, and oh so fun, and they appear in clusters not seen in the real world.
These false connections are the work of the association bias, which also influences the quality of our decisions. For example: We often condemn bearers of bad news, since we automatically associate them with the message’s content (otherwise known as “shoot-the-messenger syndrome”). Sometimes, CEOs and investors (unconsciously) steer clear of these harbingers, meaning the only news that reaches the upper echelons is positive, thus creating a distorted view of the real situation. If you lead a group of people, and don’t want to fall prey to false connections, direct your staff to tell you only the bad news—and fast. With this, you overcompensate for the shoot-the-messenger syndrome and, believe me, you will still hear enough positive news.
In the days before e-mail and telemarketing, traveling salesmen went door-to-door peddling their wares. One day, a particular salesman, George Foster, stood at a front door. The house transpired to be vacant, and unbeknownst to him, a tiny leak had been filling it with gas for weeks. The bell was also damaged, so when he pressed it, it created a spark and the house exploded. Poor George ended up in the hospital, but fortunately he was soon back on his feet. Unfortunately, his fear of ringing doorbells had become so strong that he couldn’t carry out his job for many years. He knew how unlikely a repeat of the incident was, but for all he tried, he just couldn’t manage to reverse the (false) emotional connection.
The take-home message from all this is phrased most aptly by Mark Twain: “We should be careful to get out of an experience only the wisdom that is in it—and stop there; lest we be like the cat that sits down on a hot stove-lid. She will never sit down on a hot stove-lid again—and that is well; but also she will never sit down on a cold one anymore.”
49
Be Wary When Things Get Off to a Great Start
Beginner’s Luck
In the last chapter, we learned about the association bias—the tendency to see connections where none exist. For example, regardless of how many big presentations he has nailed while wearing them, Kevin’s green polka-dot underpants are no guarantee of success.
We now come to a particularly tricky branch of the association bias: creating a (false) link with the past. Casino players know this well; they call it beginner’s luck. People who are new to a game and lose in the first few rounds are usually clever enough to fold. But whoever strikes lucky tends to keep going. Convinced of their above-average skills, these amateurs increase the stakes—but they soon will get a sobering wake-up call when the probabilities “normalize.”
Beginner’s luck plays an important role in the economy: Say company A buys smaller companies B, C, and D one after the other. The acquisitions prove a success, and the directors believe they have real skill for acquisitions. Buoyed by this confidence, they now buy a much larger company, E. The integration is a disaster. The merg
er proves too difficult to handle, the estimated synergies impossible to realize. Objectively speaking, this was foreseeable because in the previous acquisitions everything fell perfectly into place as if guided by a magical hand, so beginner’s luck blinded them.
The same goes for the stock exchange. Driven by initial success, many investors pumped their life savings into Internet stocks in the late ’90s. Some even took out loans to capitalize on the opportunity. However, these investors overlooked one tiny detail: Their amazing profits at the time had nothing to do with their stock-picking abilities. The market was simply on an upward spiral. Even the most clueless investors won big. When the market finally turned downward, many were left facing mountains of dot-com debt.
We witnessed the same delusions during the recent U.S. housing boom. Dentists, lawyers, teachers, and taxi drivers gave up their jobs to “flip” houses—to buy them and resell them right away at higher prices. The first fat profits justified their career changes, but of course these gains had nothing to do with any specific skills. The housing bubble allowed even the most inept amateur brokers to flourish. Many investors became deeply indebted as they flipped even more and even bigger mansions. When the bubble finally burst, many were left with only a string of unsellable properties to their names.
In fact, history has no shortage of beginner’s luck: I doubt whether Napoleon or Hitler would have dared launch a campaign against the Russians without the previous victories in smaller battles to bolster them.
But how do you tell the difference between beginner’s luck and the first signs of real talent? There is no clear rule, but these two tips may help: First, if you are much better than others over a long period of time, you can be fairly sure that talent plays a part. (Unfortunately, you can never be 100 percent, though.) Second, the more people competing, the greater the chances are that one of them will repeatedly strike lucky. Perhaps even you. If, among ten competitors, you establish yourself as a market leader over many years, you can clap yourself on the back. That’s a sure indication of talent. But if you are top dog among ten million players (i.e., in the financial markets), you shouldn’t start visualizing a Buffettesque financial empire just yet; it’s extremely likely that you have simply been very fortunate.
Watch and wait before you draw any conclusions. Beginner’s luck can be devastating, so guard against misconceptions by treating your theories as a scientist would: Try to disprove them. As soon as my first novel, Thirty-five, was ready to go, I sent it to a single publisher, where it was promptly accepted. For a moment I felt like a genius, a literary sensation. (The chance that this publisher will take on a manuscript is one in fifteen thousand.) To test my theory, I then sent the manuscript to ten other big publishers. And I got ten rejection letters. My notion was thus disproved, bringing me swiftly back down to earth.
50
Sweet Little Lies
Cognitive Dissonance
A fox crept up to a vine. He gazed longingly at the fat, purple, overripe grapes. He placed his front paws against the trunk of the vine, stretched his neck, and tried to get at the fruit, but it was too high. Irritated, he tried his luck again. He launched himself upward, but his jaw snapped only at fresh air. A third time he leapt with all his might—so powerfully that he landed back down on the ground with a thud. Still not a single leaf had stirred. The fox turned up his nose: “These aren’t even ripe yet. Why would I want sour grapes?” Holding his head high, he strode back into the forest.
The Greek poet Aesop created this fable to illustrate one of the most common errors in reasoning. An inconsistency arose when the fox set out to do something and failed to accomplish it. He can resolve this conflict in one of three ways: (a) by somehow getting at the grapes, (b) by admitting that his skills are insufficient, or (c) by reinterpreting what happened retrospectively. The last option is an example of cognitive dissonance, or, rather, its resolution.
Suppose you buy a new car. However, you regret your choice soon afterward: The engine sounds like a jet taking off and you just can’t get comfortable in the driver’s seat. What do you do? Giving the car back would be an admission of error (you don’t want that!), and anyway, the dealer probably wouldn’t refund all the money. So you tell yourself that a loud engine and awkward seats are great safety features that will prevent you from falling asleep at the wheel. Not so stupid after all, you think, and you are suddenly proud of your sound, practical purchase.
Leon Festinger and James M. Carlsmith of Stanford University once asked their students to carry out an hour of excruciatingly boring tasks. They then divided the subjects into two groups. Each student in group A received a dollar (it was 1959) and instructions to wax lyrical about the work to another student waiting outside—in other words, to lie. The same was asked of the students in group B, with one difference: They were given $20 for the task. Later, the students had to divulge how they really found the monotonous work. Interestingly, those who received only a dollar rated it as significantly more enjoyable and interesting. Why? One measly dollar was not enough for them to lie outright; instead they convinced themselves that the work was not that bad. Just as Aesop’s fox reinterpreted the situation, so did they. The students who received more didn’t have to justify anything. They had lied and netted $20 for it—a fair deal. They experienced no cognitive dissonance.
Suppose you apply for a job and discover you have lost out to another candidate. Instead of admitting that the other person was better suited, you convince yourself that you didn’t want the job in the first place; you simply wanted to test your “market value” and see if you could get invited for interview.
I reacted very similarly some time ago when I had to choose between investing in two different stocks. My chosen stock lost much of its value shortly after the purchase, whereas shares in the other stock, the one I hadn’t invested in, skyrocketed. I couldn’t bring myself to admit my error. Quite the reverse, in fact: I distinctly remember trying to convince a friend that, though the stock was experiencing teething problems, it still had more potential overall. Only cognitive dissonance can explain this remarkably irrational reaction. The “potential” would indeed have been even greater if I had postponed the decision to purchase the shares until today. It was that friend who told me the Aesop fable. “You can play the clever fox all you want—but you’ll never get the grapes that way.”
51
Live Each Day as If It Were Your Last—but Only on Sundays
Hyperbolic Discounting
You know the saying: “Live each day as if it were your last.” It features at least three times in every lifestyle magazine and has a slot in every self-help manual’s standard repertoire, too. For such a clever line, it makes you none the wiser. Just imagine what would happen if you followed it to the letter: You would no longer brush your teeth, wash your hair, clean the apartment, turn up for work, pay the bills. . . . In no time, you would be broke, sick, and perhaps even behind bars. And yet its meaning is inherently noble: It expresses a deep longing, a desire for immediacy. We place huge value on immediacy—much more than is justifiable. “Enjoy each day to the fullest and don’t worry about tomorrow” is simply not a smart way to live.
Would you rather receive $1,000 in a year or $1,100 in a year and a month? Most people will opt for the larger sum in thirteen months—where else will you find a monthly interest rate of 10 percent (or 120 percent per annum!). A wise choice, since the interest will compensate you generously for any risks you face by waiting the extra few weeks.
Second question: Would you prefer $1,000 today cash on the table or $1,100 in a month? If you think like most people, you’ll take the $1,000 right away. This is amazing. In both cases, if you hold out for just a month longer, you get $100 more. In the first case, it’s simple enough. You figure: “I’ve already waited twelve months; what’s one more?” Not in the second case. The introduction of “now” causes us to make inconsistent decisions. Science calls this phenomenon h
yperbolic discounting. Put plainly: The closer a reward is, the higher our “emotional interest rate” rises and the more we are willing to give up in exchange for it. The majority of economists have not yet grasped that we respond so subjectively and inconsistently to interest rates. Their models still depend on constant interest rates and are correspondingly questionable.
Hyperbolic discounting, the fact that immediacy magnetizes us, is a remnant of our animal past. Animals will never turn down an instant reward in order to attain more in the future. You can train rats as much as you like; they’re never going to give up a piece of cheese today to get two pieces tomorrow. But wait a minute: Don’t squirrels manage to gather food and save it for much later? Yes, but that’s pure instinct and—verifiably—has nothing to do with impulse control or learning.
And what about children? In the ’60s, Walter Mischel conducted a famous experiment on delayed gratification. You can find a wonderful video of this on YouTube by typing in “marshmallow experiment.” In it, a group of four-year-olds were each given a marshmallow. They could either eat theirs right away or wait a couple of minutes and receive a second. Amazingly, very few children could wait. Even more amazingly, Mischel found that the capacity for delayed gratification is a reliable indicator of future career success. Patience is indeed a virtue.
The older we get and the more self-control we build up, the more easily we can delay rewards. Instead of twelve months, we happily wait thirteen to take home an additional $100. However, if we are offered an instant reward, the incentive has to be very high for us to postpone the fulfillment. Case in point: the exorbitant interest rates banks charge on credit-card debt and other short-term personal loans, both of which exploit our must-have-now instincts.