Want to make better financial decisions? Then you’ll need to overcome this bias.
The availability bias means collective beliefs become more certain thanks to repetition in public. This can be dangerous to your financial health.
What’s the best airline in the world? How about the finest restaurant? Let’s try this one: what company runs the top credit card rewards program?
Leave aside that we often confuse “favorite” with “best” for a moment. Voting on the top choice of anything requires a number of variables, and even then the answer is likely relative.
There’s another factor at play here, however: the availability bias. Simply stated, this cognitive bias means that collective beliefs become more certain thanks to repetition in public. And this process begins with what you already know.
Essentially, the “best” (or even “worst”) of anything is a self-reinforcing process: the more we hear it, the more we repeat it, and the more we believe it.
While this bias can be a powerful meme generator, it can also lead to poor decision-making—including, as we’ll see, poor financial decision-making.
Comfort with the familiar
In 1967, the late Professor Emeritus of Psychology at the University of Wisconsin, Loren J Chapman, researched the frequency in which two seemingly related events co-occur—and how our knowledge of one brings to mind the other. Once that pairing is made, Chapman discovered that people will likely link them in the future.
This is effectively how heuristics are born: when coming across novel stimuli, we immediately draw parallel ideas or objects from memory. Approximating a relationship between one form of stimulation with another provides a mental shortcut for making sense of the world. If every category was distinct with no crossover with other categories, we’d have to spend all day learning new concepts.
For example, when we hear a new band, we immediately try to place them into a genre, and then likely compare them to other artists we know. There could be a one-to-one relationship (“they sound just like Drake!”) or, if they cross genres, multiple artists (“they sound like Drake produced by Diplo with Wu-Tang Clan samples”). This process plays out every time we’re introduced to anything novel.
Daniel Kahneman and Amos Tversky took this cognitive phenomenon a step further. At the time Chapman’s paper was published, traditional economists believed humans are rational actors that will always make financial decisions based on their best interests. (In fact, they still believe that.) These economists didn’t factor in the social nature of humans, or the biases that our social relationships create. Kahneman and Tversky did.
Shortly after Chapman’s paper was published, the pair suggested that mental availability (creating a heuristic) was responsible for the illusion of correlations. In their research, they asked a seemingly simple question:
If a random word is taken from an English text, is it more likely that the word starts with a K, or that K is the third letter?
Given that it’s much easier to think of words that begin with K (or any letter) than to conduct laborious math on the spot, participants assumed the quick processing of spinning up “words that begin with K” meant there’s more of them.
In their paper, Kahneman and Tversky cite several examples, concluding that the harder it is to pick out the obvious (the harder it is to create a heuristic), the less likely we are to pursue data to its logical conclusion. That is, heuristics fail when too many steps are involved. Instead of accepting the novel stimuli, we’re then more likely to reject it since it confuses us. As they write,
When participants were shown two visual structures and asked to pick the structure that had more paths, participants saw more paths in the structure that had more obvious available paths. In the structure that participants chose, there were more columns and shorter obvious paths, making it more available to them. When participants were asked to complete tasks involving estimation, they would often underestimate the end result. Participants were basing their final estimation on a quick first impression of the problem. Participants particularly struggled when the problems consisted of multiple steps.
This explains why we feel more confident with the familiar than the unknown. It also explains why the unknown has to be somewhat familiar for us to garner any sort of belief in it. If it’s too foreign or abstract a concept—if there’s nothing for us to compare it to—then we’re likely to reject its validity, or even its presence. And that can be a problem.
Defining the “best”
While the availability bias is applicable to all domains of life, let’s look at how it affects economics. In a 2010 study, researchers found that predictive powers in the stock market were weakened due to easily recalled information. Analysis and risk availability were both influenced by the individual participant’s heuristics. Instead of spending time doing deep research, investors consistently took shortcuts to come to quicker conclusions—which were often not the best conclusions for their portfolios.
To test this, another set of researchers asked participants how the S&P 500 Index performed in the years 2009-11. Over half of respondents believed the market was flat or down coming out of the housing crisis over those years, when in reality, the Index saw annual returns each of those years.
Even more ironically, the largest number of people surveyed thought 2009 was the worst year of that period, when in reality it produced the highest annual returns. This is likely due to that year’s proximity to the financial crisis of 2008—readily available information that, had they invested in 2009, would likely have decreased their appetite for risk.
To return to the initial questions in this post: what’s the best airline? Restaurant? Credit card rewards program?
Again setting aside your “favorite,” chances are your replies are influenced by what you’ve read about this or that program. Sure, if you’ve consistently had positive experiences on one airline, you’re likely to reply in its favor. Yet few people fly enough to truly weigh all the world’s airlines to make such a judgment. So we take shortcuts.
This is where marketing comes in. As we explore in our series on rewards programs, credit card companies spend a lot of money marketing points to bring in new customers (while consistently devaluing older customers). The more you see incredible offers about huge tranches of points on your social media feeds, the more quickly that company will come to mind when considering rewards programs. They’ve made themselves as available as possible so that you’ll link “our rewards program” with “best.”
Which could lead to making financial decisions that aren’t in your best interest, like investors following the 2008 crisis. Sometimes, just a little bit of research means more options become available for consideration. You only need to overcome this bias and not take every shortcut available to you.