Michael Mauboussin is the author of The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing (Harvard Business Review Press, 2012), Think Twice: Harnessing the Power of Counterintuition (Harvard Business Press, 2009) and More Than You Know: Finding Financial Wisdom in Unconventional Places-Updated and Expanded (New York: Columbia Business School Publishing, 2008). More Than You Know was named one of “The 100 Best Business Books of All Time” by 800-CEO-READ, one of the best business books by BusinessWeek (2006) and best economics book by Strategy+Business (2006). He is also co-author, with Alfred Rappaport, of Expectations Investing: Reading Stock Prices for Better Returns (Harvard Business School Press, 2001).


Visit his site at: michaelmauboussin.com/

Michael Mauboussin: Common Investor Biases And Where They Come From

  • Humans are social and generally want to be part of the crowd. Studies of social conformity suggest that the group’s view may shape how we perceive a situation. Those individuals who remain independent show activity in a part of the brain associated with fear.
  • We are natural pattern seekers and see them even where none exist. Our brains are keen to make causal inferences, which can lead to faulty conclusions.
  • Standard economic theory assumes that one discount rate allows us to translate value in the future to value in the present, and vice versa. Yet humans often use a high discount rate in the short term and a low one in the long term. This may be because different parts of the brain mediate short- and long-term decisions.
  • We suffer losses more than we enjoy gains of comparable size. But the magnitude of loss aversion varies across the population and even for each individual based on recent experience. As a result, we sometimes forgo attractive opportunities because the fear of loss looms too large.


In recent decades, psychologists and economists have cataloged the ways in which human behavior deviates from economic theory.1 They have done this mostly through experiments and observation. Daniel Kahneman and Amos Tversky, psychologists who formalized this research, showed that individuals use heuristics, or rules of thumb, to make their judgments. These heuristics lead to biases when compared to normative economic behavior.2 For example, people generally place too much weight on information that is available to their minds, often associated with an event that is vivid or recent, and overestimate the probability of a similar event occurring again.

Neuroscientists have joined psychologists and economists to create the field of neuroeconomics. One of the goals of neuroeconomics is to understand how certain behaviors are linked to specific brain activity. The theory of modularity says that particular cognitive functions are associated with different parts of the brain. Neuroeconomics allows researchers to connect behaviors to specific regions, providing insight into how the brain handles certain cognitive challenges.

[drizzle]In this report, we examine four situations where individuals make poor choices and review the research to show where the brain makes those decisions. In each case, we present some ideas about how to overcome the potentially suboptimal choice.

Michael Mauboussin – Mental Mistake #1: Social Conformity

In the summer of 2015, the CFA Institute surveyed 724 investors about which behavioral biases affect decision making the most.3 More than one-third of the investors voted for herding, or “being influenced by peers to follow trends.” Herding is problematic because an investor can’t beat his or her peers by doing the exact same thing that they are doing. Further, herding can lead to inefficient market prices.

Humans are social beings, and conformity makes sense in a wide range of contexts. For example, you are well served to do what others are doing when they know more than you do. Conformity also encourages others to like you, which can confer loyalty and safety. Problems arise, however, when the group is wrong.

Solomon Asch conducted the most famous experiment of social conformity in the 1940s and 1950s.5 The researcher showed two cards to the subjects, who were in groups of seven to nine. One card had a single line on it and the other had three lines of varying lengths, including one of the same length as that on the first card (see Exhibit 1). The task was to choose the line of the same length. Going around the room, the participants answered one after the other. The experiment opened uneventfully as the group selected with near perfect accuracy.

Michael Mauboussin Common Investor Biases

The experiment then started for real. Asch had arranged for all of the members except one to be in with him on the experiment, making that individual the true subject. The researchers instructed the confederates, who answered publicly before the true subject, to give the wrong response in two-thirds of the trials. In a set of 123 experiments, the subjects conformed to the majority’s wrong answer 36.8 percent of the time. While about one-quarter of the subjects remained completely independent throughout the experiment, one-third aligned with the majority most of the time.

Asch was fascinated by this degree of social conformity and interviewed the subjects immediately following the experiment. Based on their responses, he surmised that three “distortions” could explain the behavior of the conformers.

Distortion of judgment is a case when the subject concludes that the group knows more than he does and hence conforms. “These subjects,” wrote Asch, “suffer from primary doubt.”

Distortion of action captures instances when the subject knows the right answer but feels more comfortable being part of the crowd but wrong. According to Asch, “They yield because of an overmastering need not to appear different.”

Distortion of perception occurs when the subjects are unaware “that their estimates have been displaced or distorted by the majority.” In other words, the majority’s answer changes how they perceive the answer. He added that perception is the least popular explanation for conformity.

While Asch’s curiosity was laudable, interviews are not a rigorous way to determine the source of social conformity. In the mid-2000s, neuroscientists picked up where Asch left off. They were able to use functional magnetic resonance imaging (fMRI) technology to pinpoint the mechanisms of social conformity within the brain.

First, scientists have been able to replicate Asch’s results consistently.7 Subjects conform not only for perceptual tasks, such as identifying line lengths, but also for subjective evaluations including judging the quality of paintings. There is even some evidence another species, chimpanzees, conforms.

Michael Mauboussin Common Investor Biases

Michael Mauboussin Common Investor Biases

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