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What Rabbits Can Teach You About Investing

Earlier this week while I was taking a walk in the field behind my home, I came across two rabbits eating grass. They were very close to each other and both were equally close to a brush pile. As I begin to walk past them, one sprinted into the nearby brush pile while the other stayed frozen in place. At that moment, I witnessed both flight and freeze responses. 

Rabbits are like furry calculators that rely on instinct to determine what they should do to receive the most favorable outcome, which is to survive an attack from a predator. Each rabbit came up with a separate answer to this problem, one ran away and the other froze.  

If I were a predator and did eat the rabbit that froze, did that rabbit make a bad decision or just get unlucky? Natural selection has a bias towards the outcomes that result in survival.  The rabbit who can survive the longest will have the most offspring and those offspring will carry on the same traits as their parents.  

Survivorship Bias in Investing

This bias towards survival exists in investing as well. We tend to look at only the successful companies and investors. We ignore the luck involved and chalk it up to skill. This business natural selection process chooses which traits appear to be successful in the past environment. It does not take into consideration the countless number of competitors that failed during this process or account for the uncertainty the future brings. Quite often, poor decisions that work out become good decisions in hindsight. The decision-making process is rarely considered. 

Did the rabbit who froze make a bad decision or just have bad luck? The rabbit’s brain must have determined inaction had the best rate of survival given what it knew at the time. 

Making Better Decisions

People tend not to take personal accountability for their own mistakes. This stunts their ability to move forward in learning how to become more successful. We tend to judge our decisions based on the results. If it’s a bad outcome, we assume it was a bad decision and vice versa. We ignore how much luck plays a role in the equation. 

In investing, you must make decisions based on incomplete facts. You must embrace the uncertainty and estimate the probability of various outcomes. We should have humility and take mistakes in stride. When things go wrong don’t blame others. Instead, analyze your approach and learn from your mistakes. This approach helps improve decision-making going forward. 

We must recognize the uncertainty inherent in life, understand our own behavior and biases and learn from them. It can also be prudent to seek unbiased advice to test your logic and get feedback when you are making decisions in a field that is not within your personal expertise. 

Which path will you choose?

If you have any questions, feel free to reach out to us at info@westernreservecm.com    

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Don’t just do something, stand there.

There are times people have an impulse to act in order to gain a sense of control over a situation and we focus on the benefits of action and ignore the costs. This term has been named Action Bias. 

Reasons for Action Bias:

There are times when thoughtful inaction is statistically the correct choice, but prior research has found the urge to take the dramatic action approach can trick us into bad decisions that are justified by saying, “Well, at least you tried.” Doing nothing during times of uncertainty is extremely hard for us because it goes against our instinct to take action. In our minds, it is better to try something and lose compared to doing nothing and losing the same amount. Financially, we may feel personally responsible to take action to protect our savings for our loved ones.

Action Bias is particularly likely to occur if we do something for others or others expect us to act a certain way. This can be illustrated by the tendency for soccer goalkeepers to jump to the left or the right of the goal during a penalty kick attempt even though statistically they would be better off if they stayed in the middle of the goal. The likely reason for this is the effort of jumping to make a save looks better than standing in place. 

Action Bias may also be more likely among overconfident individuals or if a person has experienced prior negative outcomes or subsequent action would be a failure to do something to improve the situation.

Way to combat Action Bias:

Periods of uncertainty can be scary for anyone, but there is no reason our fear and anxiety should get in the way of our financial plans. Use the listed techniques to make more logical decisions and stay the course.

Beforehand

• Make a plan
• Set realistic expectations
• Educate yourself on the types of biases 
• Pre-commit to the actions you will and not will take

What to do during the time of crisis

• Refocus on your goals
• Slow down
• Take a step back from your emotions
• Redetermine what really matters

Reframe situation

• Focus on the positive
• Look to help others
• Play the devil’s advocate
• Remember events from the past
• Determine if your financial plan is still on track to meet these goals.

Take action where it counts

• Increase your savings rates
• Look for tax saving opportunities
• Capitalize on low interest-rates

What to do after 

• Perform a post-mortem and determine if the steps you put in place were sufficient during the time of crisis. If not, assess where improvements can be made in your preparation for the next time.

We must remember our biases are fundamental to who we are, all we can do is be aware of the types of biases we personally exhibit ahead of time and plan accordingly.

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