Behavioural science has done a marvellous job of pointing out the mistakes most human beings make in estimating probability, and the extent to which we are influenced by each other, in making irrational decisions.
As a form of criticism and a prod for clearer thinking, these discoveries are invaluable. However, whereas behavioural science does a great job of describing human decision-making in light of normal (good and bad) events, we must be careful when applying it to “fat tail” events, like a global pandemic.
We should all, at the very least, be aware of our biases – we can control our own behaviour, provided we can see it for what it is. But the behavioural insights we’re referring to are based on robust, appropriate data about the past.
For those trying to predict human behaviour in the context of coronavirus, that data isn’t easy to come by.
Behavioural scientists (and politicians, for that matter) who assume that the public is behaving irrationally would do well to consider that they themselves are falling prey to a form of meta bias: an ironic application of the curse of knowledge and the illusion of control, manifest in the assumption that people are idiots.
Nowhere has this been more evident than in the case of the current pandemic. From the start – though their tone has moderated as the full scope of the virus became apparent – experts were jumping over themselves to explain how overblown our fear is and how foolish we are to stock so much toilet paper.
Perhaps it is these experts, and not the rest of us, who are “coronabiased.”
“I am not scared of COVID-19,” infectious disease expert Abdu Sharkawy of the University of Toronto wrote in a social post that went viral last month.
“What I am scared about is the loss of reason and wave of fear that has induced the masses of society into a spellbinding spiral of panic, stockpiling obscene quantities of anything that could fill a bomb shelter adequately in a post-apocalyptic world.”
In a similar vein, legal scholar and Harvard law professor Cass Sunstein confusingly wrote: “At this stage, no one can specify the magnitude of the threat from the coronavirus. But one thing is clear: A lot of people are more scared than they have any reason to be. They have an exaggerated sense of their own personal risk.”
One wonders how a threat with literally unspecified magnitude in one sentence can suddenly become exaggerated by the next.
But fear of coronavirus is not irrational. Individual people can see the potential for this infectious disease to incur tremendous damage to their own lives, as well as to global economies – it’s got fat-tail event written all over it.
Some people will have jumped straight to preparing for the worst-case scenario, and some will have started by assuming the best case.
As new data come in from trusted sources, we are all adjusting our behaviour and making decisions under uncertainty, not just about the spread of the disease but about the knock-on effects on our day-to-day lives.
“Calling people irrational for being more afraid of coronavirus than they are of car accidents misses the point that these are two very different risks”
Philip Maymin, insight partner at Essentia Analytics
Calling people irrational for being more afraid of coronavirus than they are of car accidents misses the point that these are two very different risks: the worst day ever of car accidents, while sad, won’t change much about the world.
The worst day ever of coronavirus can paralyze a country, a continent, or a global economy. That’s the fat tail – and it’s not irrational to prepare for it, when you’ve seen evidence pointing in its direction.
One of the few people who consistently makes this point is Nassim Nicholas Taleb, author of The Black Swan and numerous other books and mathematical articles that prove a variety of facts about tail risks.
One of his major findings, which goes some way to justify human behaviour in light of coronavirus, is that whatever worst case we have seen so far is, it’s nothing compared to what might come next.
For investors, perhaps our most important lesson is to separate our market behaviour from our personal behaviour. If you can remain rational and detached in evaluating market conditions, then go home and stock up on toilet paper, that’s much better than the other way around.
In times like this, when other aspects of our lives are being disrupted, it is especially difficult to stick to your investment process. It’s worth having a close look at how your process has held up to times of massive uncertainty and paradigm changes – for example, the 2016 US election and Brexit.
In those cases, did we stick to our investment process? Did we override it? Which approaches turned out better, and why?
It’s important and valuable to spot and predict behavioural biases in yourself and others, but it’s counterproductive to infer that humans are stupid or automatons. People are indescribably brilliant. Human knowledge is, in fact, the only possible source for a solution to the coronavirus.
Dr Philip Maymin is professor of analytics at Fairfield University Dolan School of Business, and an insight partner at Essentia Analytics.
Five Ways to Stick to Your Investment Process
Document it: Create a process checklist for each type of investment in your portfolio – and use it. There are lots of software tools on the market that can help: Tallyfy, Evernote, and Trello, to name a few.
Keep your eye on the horizon: When planning scenarios, focus on your actual investment horizon. During a crisis, our natural tendency is to focus on the short term. But if you’re investing on a five-year view, it’s worth forcing yourself to lift your gaze: how do recent events potentially affect the value of your investments five years from now? Many investments look terrible during a crisis, but if their fundamentals haven’t changed, their long-term prospects may be as good – or even better – than ever.
Record the WHY: When you decide to act – or not to act – record the context in which you made the decision and the reasons that were foremost in making it. Ideally, do this in a structured way, so you can analyse the data later. But the act of doing it, alone, is helpful for ensuring your decisions are as deliberate as possible.
Nudge yourself: Pre-set notifications can give you a heads-up to revisit your conviction at critical points in an investment’s lifecycle: after a certain period of time, after the price has moved up (or down) by a certain percentage, or after a key metric has crossed a threshold. If, at that point, you wouldn’t still be buying the security, you might want to ask yourself whether you should be selling it.
Prioritize the process: It might sound obvious, but the single most powerful thing you can do is keep your process top-of-mind and make a daily commitment to following it, in the knowledge that there are a million derailers out there. It’s easier said than done.
Source: Essentia Analytics