Welcome to the sixth part of this series which is based on the book “The Art of Thinking Clearly” by Rolf Dobelli.
We aim to highlight a list of biases, fallacies and illusions that impair judgement and impede good decision-making.
You can refer to parts one through five in the links below.
Part 1 – click HERE
Part 2 – click HERE
Part 3 – click HERE
Part 4 – click HERE
Part 5 – click HERE
Meanwhile, let’s explore yet another three conditions which negatively affect our thinking process.
False causality
False causality describes a situation where causation is attributed to an outcome even though other factors may have been at play.
Investors make this common error when they assume that certain actions or events trigger share price reactions.
However, due to the randomness present in the world, many outcomes could have been a result of influences other than the reasons that the investor had assumed.
It is dangerous for an investor to be overly reliant on causality.
This is because they end up mistakenly assuming that their investment actions or decisions contributed to a positive outcome.
In reality, other random reasons or factors may have been at play.
Such investors may then seek to replicate their success by taking similar actions, only to be disappointed when the outcome is different from what they expected.
Alternative paths
Alternative paths represent a line of thinking which considers different options we could have taken which may have resulted in different outcomes.
When investing, you need to consider a wide variety of options to choose from that allow you to choose either different types of securities (e.g. bonds or equities), or different kinds of companies (e.g. utilities versus banks versus REITs).
Each option would have resulted in outcomes which may differ greatly from the outcomes of decisions made.
These outcomes can be either positive (e.g. the investor avoided investing in junk bonds or lousy companies) or negative (e.g. missed opportunities to invest in a great company).
It’s useful to consider alternative paths as this line of thinking opens us up to ideas on how we could have better allocated our capital.
In addition, it may also teach us lessons on what to do or not to do.
Forecast illusion
The forecast illusion applies to any person or organisation that regularly provides forecasts for either the economy or specific companies.
Phillip Tetlock, an author and a professor at the University of Pennsylvania, studied thousands of predictions made and found out that hardly any were accurate.
The problem with the forecasting industry is that when they get it right (through coincidence or luck), they receive a ton of praise.
But when they get it wrong (and this is more frequent than you might suspect), they do not receive any blame for it.
This makes the industry prone to making excessive forecasts and then claiming credit when some of them are right, even though the majority may be completely off the mark.
As the saying goes, even a broken clock tells the correct time twice a day!
Investors, therefore, need to take such predictions with a huge dose of salt.
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Disclosure: Royston Yang does not own any of the companies mentioned.
