Let’s talk about financial markets for a moment.
Of the many explanations behind how financial markets boom and bust, one of the most widely believed opinions finds human sentiment as the lynchpin. Inflated confidence, greed, fear, hype – these are far more strongly the drivers of market ebbs and flows than broad socio-economic logic. To the point that analysts must keep a close watch on the ‘market psychology’, for, how the market ‘feels’ about something greatly affects how that thing pans out, no matter how much rational thought tell one otherwise.
This perception that is rife in financial markets – easily one of the more logic and data-driven spaces – strikes at the heart of the common belief that humans are creatures of reason and efficient decision makers. And it is a perception that underscores a profound truth:
“Human decision making is, by and large, an irrational and an influenced process.”
Not to say that rationality is completely lost on us, but to believe that most people tend to take decisions, especially critical ones, logically and with a clear mind will be false.
Today, there is enough empirical evidence showing that while humans are capable of prudent decisions, people’s judgments are almost always heavily influenced by the ‘implicit.’ From the reasons to wear a certain piece of clothing to a choice of a retirement fund.
And these ‘implicits’, as confirmed by more than four decades of scientific research, are what we call cognitive biases.
Cognitive biases: A primer
Cognitive biases are personal thumb rules or mental shortcuts we use for arriving at decisions. Learned or acquired, it is a cognitive bias that causes one to deviate from the path of rational thought, leading them to make poor inferences, flawed judgments, and irrational decisions.
And the fact is that there’s little one can do to prevent cognitive biases from settling in. We live a multidimensional and complex world. Often surrounded by situations and conditions that prevent us from thinking clearly. Our personal realities are tethered to that of other people’s and we are creatures driven by motivations that reason knows not of. And it is from the complex web of these realities that human decisions must emerge.
At companies where success and growth require people to make good business decisions every day, there’s little room from bias-born choices. Which means employees have to be able to plug into their innate value systems as well as that of the organization’s to perform optimally. Here, behavioral economics offers a meaningful way to intervene in people’s value systems and ‘nudge’ them in the direction of better and rewarding behaviors.
‘Nudging’ away the irrationality
In his Nobel winning work, behavioral economist Richard Thaler established that ‘humans are predictably irrational.’ And if irrationality can be predicted, he said, it can also be steered or ‘nudged’ in the direction of better.
Unlike classical economics, Thaler’s work in behavioral economics consciously moves away from the notion that humans are – inherently – creatures of logic and brings to light the influence of irrationality during decision-making processes. He explains in his award-winning work how hardwired biases and deeply lodged values cannot reasonably be removed but they can be influenced in a way to cause someone to de-bias and think clearly. This, by using small, meaningful interventions or ‘nudges’, introduced during critical decision-making moments, causing someone to choose differently.
Thaler’s work has been dubbed particularly useful for organizations who want to influence their employees to perform better. Using techniques and tools that introduce ‘nudges’ during key evaluation or decision-making process, say, when an employee is chasing a sale goal, organizations can successfully get their people to align their ambitions, motivations, and internal goals to those of the company.
Building better decision conditions
In the early 2000s, borrowers in the United States were encouraged to take out mortgage loans because the real-estate prices had fallen. Most borrowers couldn’t reasonably pay back their loans but the idea that you ‘shouldn’t take out loans’ was contrary to the conditioned learning as was ‘not owning a home’. By the time the real-estate prices had risen in 2007, outstanding mortgage payments in the U.S. were over a trillion dollars and the economy found itself on the brink of collapse.
Aware of the outsized influence of irrationality on individual decisions and behaviors, financial market analysts have come to understand that it is wiser for the socio-economic institutions and policymakers to simply build better decision-making conditions than to rely on people to take better decisions. For, instead of holding people accountable for their illogical and sentiment-driven choices, it is wiser for the institutions to uphold and reinforce market conditions that get people to choose better.
New age companies can take a leaf from this and build rewarding organizational processes by relying on principles of decision science and behavioral economics to design tools that influence people in meaningful ways. Ways that help people not only overcome cognitive biases during critical decision moments – such as during a sales run or a team goal chase – but also enables them to take better decisions every day.