People tend to see patterns where they don’t exist, and they are generally terrible at making unbiased decisions, according to Toby Moskowitz, co-author of Scorecasting: The Hidden Influences Behind How Sports Are Played and Games Are Won and a finance professor at the Yale School of Management, who spoke at the recent 2018 Investments & Wealth Institute Investment Advisor Forum.
These two traits are largely attributable to people’s lack of understanding of randomness, and they can lead to poor decisionmaking in everything from investing to dating.
People’s difficulties in understanding randomness can be seen in the fact that they are inclined to think that it’s more likely, when flipping a coin ten times, to get a mixture of heads and tails than to get all heads or all tails.
To illustrate the human tendency to see patterns where they don’t exist, Moskowitz described the common phenomenon – what he calls the “hot-hand fallacy” – of people saying that some sports figure is on a winning, or losing, streak. But, if one looks at year-long hitting (baseball), shooting (basketball) or other such records of players said to be on streaks, one finds that most of the patterns are explained by randomness.
That is, if a computer is programmed to generate a made-up player’s record, it’s likely to come up with the same frequency and duration of “streaks” seen in a hot (or cold) player’s record.
Similar evidence for the fallacy of streaks can be seen if one looks at the records of Kobe Bryant versus Shaquille O’Neal. While Bryant is thought to be the superior free thrower, if one looks at their records over time, the Bryant advantage diminishes considerably.
This kind of misperception affects decisionmaking. Research shows that if teammates think a particular teammate is on a streak, they’ll pass that player the ball more. Similarly, in investing, if a mutual fund outperforms, money flows into that fund, even though many studies show that a fund’s past performance doesn’t predict future performance.
The obverse of the hot-hand fallacy is the gambler’s fallacy, which is the tendency to believe that if a series of events with two possible outcomes are random, the outcomes will trade off. So, when people try to make unbiased decisions, they often confuse producing alternating results with being unbiased.
To illustrate, Moskowitz described research showing that baseball umpires had a tendency to call a ball for a hard-to-call pitch going into the same area of the strike zone as the previous pitch, if he’d called the previous pitch a strike.
Similarly, he explained how instructors, grading a stack of papers, tended to give a lower grade to a paper if it came after several papers to which they had assigned higher grades.
Moskowitz further described research showing that judges deciding on the cases of asylum seekers were more apt to deny someone asylum if that person appeared in court just after the judge had just granted asylum to several people in a row, regardless of the merits of the various cases.
Comparable biases can be seen in online dating, loan decisions and any number of other endeavors. Loan officers reviewing loan applications have been found to be more apt to deny an application after approving several in a row, again regardless of the relative merits of the applications.
To avoid the pitfalls, it not only helps to be aware of them, but also to seek more information, and realign incentives, Moskowitz said.
If the loan officers, for example, were paid when they approved a strong application and penalized for approving a faulty one, researchers found that the officers spent more time reviewing each application and the error rate declined.
But, the suboptimal decisions the fallacies can lead people toward probably can’t be eliminated entirely, Moskowitz added.