How bias affected our decisions during the pandemic

By Joseph Zaccardi

The COVID-19 pandemic unleashed an avalanche of uncertainty and emotions for business owners and investors from which we are still digging out. We shifted our focus to self-preservation and our own wellbeing, which has hampered our ability to make rational decisions. Errors in our judgment in making mission-critical and time- sensitive decisions during a crisis could force us to rely more heavily on heuristics (mental shortcuts) and have long- lasting impacts on our businesses and wealth.

For years, a subset of economics and psychology has focused on the processes and heuristics we use to make decisions and the unconscious biases that can influence each choice we make. We are often unaware that our decisions are being swayed by our primitive minds, and we are often unable to judge the degree to which our analysis is tainted by biases. Many of us are currently experiencing emotions related to the survival of our businesses, losses in investments and the health of our families and employees. The present economic and political uncertainty, coupled with emotional elements, creates the perfect recipe for our biases to be magnified. Four biases that seem particularly salient during these times are hindsight bias, availability bias, overconfidence and status quo bias.

Hindsight bias refers to our tendency to overestimate our ability to predict outcomes that were almost impossible to predict at the time. It is difficult to consider the current state of the world without concluding, “It was obvious in January that this was a disaster in the making.” The news and evidence were available, doctors had raised alarms and we collectively failed to act. However, the future is always more uncertain than it appears when we look at past events with knowledge of the outcome.

One way to battle hindsight bias is to keep records about the important decisions we make. As my colleagues and I look back at our investment committee notes from late January and early February, we see little mention of the novel coronavirus and its potential effect on our portfolios and the U.S. economy. Based on our review of expert opinions from the WHO and the CDC and countless economic research papers, we decided the virus would not have a widespread and long-lasting impact. One of the few mentions in our records is, “The equity markets and the economy seem to be underreacting to the potential effects of the virus, while media companies seem to have blownit out of proportion.” We were clearly wrong at the time, and can recognize that the effects of the coronavirus were not so obvious during the early days of its spread.

Availability bias is our tendency to think examples that come easily to mind are more representative of reality than is actually the case. Even if history tends to rhyme, the story is much more boring than the one we tend to recall. For instance, people naturally tend to compare the current extreme economic disruption to what may be the worst financial crisis in their lifetime (2008 global financial crisis) or to the worst in modern history (the Great Depression). However, there are numerous cases of less severe economic disruption from which we could draw lessons. Our minds are programmed to think of the most recent or easily recalled instances of an event and to draw (sometimes) meaningless patterns between the two.

In order to combat availability bias, we need to set up decision-making structures to prevent us from focusing on recent events and events that are easy to recall. Is the economic disruption in the current crisis really similar to the global financial crisis? Are the causes, symptoms or likely outcomes the same? Or is our emotional response, our gut instinct, similar and thus forcing us to draw patterns where none exist?

Overconfidence is our tendency to overestimate our skills and the accuracy of our predictions. Successful business leaders often project their past successes to other ventures, often ignoring inherent risk or the role of chance in the outcome. In times of uncertainty, we routinely overestimate the probabilities of positive outcomes. No one knows the future path of the coronavirus, the timing and efficacy of vaccines, or how long it will take the economy to returnto “normal.” Basing decisions upon assumptions of these unknowns, no matter how confident you are, is simply guessing.

Combatting overconfidence is quite challenging. We rarely have complete information and luck often plays a role, so the best decision may not always be the correct one when reviewed with the benefit of hindsight. We advocatecreating governance structures to avoid decisions based on “gut feelings” or unilateral irrational actions. Forexample, we prevent our clients from becoming overly conservative or aggressive during volatile times and trying totime the market. At the corporate level, diversity on boards and designating a “devil’s advocate” can serve thispurpose.

Status quo bias is the tendency to take the current state of affairs as a reference point and to perceive any change in that baseline as a loss. These trying times have offered us numerous opportunities to change and grow as people and organizations; however, we are often burdened by the baseline we held a few short months ago. For instance, prior to shutdowns, how many of us were truly prepared to empower our employees to set their own schedule and work routines outside the structures of a traditional office? Many of us saw the change to working from home as a loss, rather than an opportunity to add resiliency to our business and our lives.

Status quo bias can be viewed as a reliance on lazy decision making or being overly conservative. Instead of making new decisions or changing, we simply continue doing things the way we have always done them. It stands to reason that this bias may be more pronounced in times of increased uncertainty and stress, such as a global pandemic and economic crisis. One strategy for limiting status quo bias is to remove it as an option in our decision making. Inother words, we can ask ourselves, “If we had to do something, what are our options and what could be theconsequences?” We can then compare these options to the option of maintaining the status quo.

The current crisis has increased uncertainty and stress, which can lead us to utilize heuristics in our decision making and fall victim to behavioral biases. Hindsight bias, availability bias, overconfidence and status quo bias are four behavioral biases that may have impacted our response to these uncertain times. Our ability to identify our behavioral tendencies, mitigate them and reach a rational decision will define our experience during the coronavirus pandemic and future crises. At the very least, the current situation provides us an opportunity to self-reflect and see which biases are most likely to affect our decisions in times of great uncertainty.

Joseph Zaccardi, CFAis portfolio manager at Drexel Morgan Capital Advisers (