Decision-Making Biases

Decision-making biases refer to cognitive shortcuts deployed in quick, efficient decision-making that lead to irrational choices due to reliance on experience. It saves mental energy while helping make decisions in unique situations with limited information.

Everyone applies it to personal work and financial decisions impacting choices such as investments, job selection, hiring process, housing, purchasing, and education. Hence, these biases are inherent in human cognition. And it can lead to errors, distortions, or irrational choices when individuals are making decisions. Awareness of these biases is essential to make more rational and informed decisions.

• Decision-making biases are cognitive shortcuts used for swift and efficient decision-making, resulting in irrational decisions due to subconscious dependence on prior experiences.
• It aims to conserve mental energy, facilitating choices in specific scenarios with limited information.
• Its types include confirmation, anchoring, availability, representativeness biases, affect heuristic, sunk cost fallacy, loss aversion, framing effect, and halo effect.
• Employ a systematic approach to avoid decision-making biases: start with a clean slate, question the status quo, seek diverse perspectives, challenge assumptions, deliberate, and utilize decision frameworks.

Decision-making biases are technically defined as cognitive biases inherent in human cognition and can lead to errors, distortions, or irrational choices when making decisions. These mental shortcuts often result in wrong decisions, leading to investment losses or risks. Therefore, these biases and errors can significantly impact decision-making processes in various aspects of life, including personal, professional, financial, and social domains.

It works by how our brain processes information received to provide a solution or decision. It tries searching for any past similar situation and decisions it made or others made to escape it. Hence, it suggests the individual's quickest and best available decision-making process. Nevertheless, it is not based on rationality, affecting the decisions made on the spot. Therefore, most of the time, decision-making bias negatively impacts the choices and outcome of the action.

Furthermore, its usability includes a quick, lifesaving decision in dangerous or time-sensitive circumstances. Often, when a person has to decide upon unfamiliar or complex topics or when tired, it comes into play.

In addition, this bias occurs when individuals continue to invest resources into a decision or project. Since they have already invested a lot, even when it is clear that the costs outweigh the benefits. They can impact choices in various contexts. For instance, from personal matters like buying a car or choosing a career path to professional business, and policy-making decisions. Thus, individuals often start with an initial anchor point and then fail to adjust sufficiently away from that anchor when new information is presented.

One must know the numerous types of decision-making biases that affect correct decision-making. Hence, let us study the decision-making biases listed below:

• Confirmation bias: It is the inbuilt ability of the human brain to act to confirm the existing faith and belief.
• Anchoring bias: It is the weakness of the brain to act on a situation on the first piece of information available to it.
• Availability bias: It gives more importance to readily available information or easily recalled from memory, often due to recent exposure or emotional impact.
• Affect heuristic: It makes humans decide on any activity, choice, or situation using their emotions rather than their rational thinking and information.
• Overconfidence Bias: This bias overestimates one's abilities, knowledge, or the accuracy of one's beliefs and predictions. Hence, this can lead to taking on excessive risks.
• Sunk cost fallacy: It means that a person keeps investing in a loss-making security or project as they have already invested too much in it.
• Loss aversion: It is the weakness of a person to avoid losses only instead of seeking out gains.
• Framing effect bias: It is the effect where humans get deceived on how an information or situation is presented to them.
• Halo effect: The human brain can prepare a complete impression of a person's personality based on any trait of a person
• Dunning-Kruger effect: People can assess their character and competence. Usually, low-skilled people think they are over-competent, and vice versa.
• Endowment Effect: Overvaluing items simply because they are owned or possessed leads to reluctance to part with them or a tendency to demand more for them than they are worth.

Understanding these common decision-making biases can help individuals and organizations make more rational and informed decisions.

Let us use a few examples to understand the topic.

Example # 1

In the case of PepsiCo's employment procedures in 2012, a clear bias in decision-making was evident. Black candidates suffered disproportionate exclusion due to the company's selection process. They used criminal background checks to assess job applicants who had faced arrests but were acquitted. Hence, this discrimination led to the unjust exclusion of over 300 black candidates.

Moreover, such prejudiced decision-making arose from an unconscious reliance on arrest records irrelevant to the job requirements. Therefore, the $3.13 million settlement imposed on PepsiCo will primarily benefit the black applicants who were adversely affected by this discriminatory practice. Consequently, it is vital to critically evaluate decision-making procedures to ensure fairness and inclusivity in hiring processes and rectify the impact of decision-making biases. Thus, the settlement and subsequent policy overhaul underscore its necessity.

Example # 2

Imagine an investor named John considering buying a tech company's shares. John watches a financial news program. An expert analyst suggests that the "fair value" for these shares should be around $150 each based on a detailed analysis of the company's financials and industry trends. Later that day, John starts researching the stock and notices that the current market price is significantly lower, at $120 per share.

However, John becomes anchored to the $150 figure he heard on the news earlier. He can't shake the feeling that he's found a great deal and believes the stock is undervalued. Ignoring other relevant factors, such as the company's recent performance, the broader market conditions, and risk tolerance. John decides to invest heavily in the stock based on this anchor price.

As a result of the decision-making bias, John may be making an investment decision that could be more rational and well-informed. Moreover, he needs to rely more heavily on an arbitrary anchor point, the $150 value suggested by the analyst, and consider all the relevant information. Therefore, this decision may lead to financial losses if the stock's actual value is, in fact, closer to the market price of $120 or if other unforeseen factors affect the stock's performance.

It is essential to make correct decisions in everyday life to avert any monetary or reputation loss. Hence, let us know how to reduce the biases.

• Using a process: Have a definite process like goal identification, information gathering, weighing the pros & cons of different choices, and making logical decisions.
• Starting with a blank canvas: There should be no preconceived notion or bias before deciding. Before deciding, one must write down complete data about an event, person, or place.
• Challenging the current state: One must question every existing thought, stereotype, and status quo concerning everything.
• Explore diverse viewpoints: One must obtain different people's perspectives to get their opinions, experiences, and views on a situation. It will help one to make intelligent and healthy decisions instead of following one's bias.
• Gather extra data: More and more internal and external information must be collected concerning any situation or yet-to-be-made decision. It helps remove unnecessary information, stereotypes or biases from one's mind and make rational decisions.
• Challenge assumptions: One must try to argue against the mental position going to be taken or inclined to take. It helps pick out negatives and problems inherent in the position taken by the person and avoid wrong judgments.
• Self-examine beliefs: In every situation and pre-decision-making time, a person must take time to examine self-beliefs, views, societal beliefs, and any hidden bias one has. It aids in understanding the biases that may come into play while deciding on any situation or topic.
• Slow the decision-making process: One must put more time into self-contemplating opinions, adrenalin rush, peer pressure, and inbuilt biases. It clears all bad biases and allows sound and healthy decisions.
• Ask for feedback: Always take feedback from friends, relatives, or colleagues to review one's decision. They will point out any potential bias in the decision-making process, allowing for correction and making logical, rational decisions.
• Apply decision frameworks: Finally, one can take help from existing decision-making frameworks to make fair, transparent, and bias-free decisions.

This has been a guide to what are Decision-Making Biases. Here, we explain it in detail with its types, examples, and how to avoid it. You can learn more about it from the following articles –

• Bias Ratio
• Data Snooping Bias
• Durability Bias