Knowing your clients’ risk tolerance and confidence levels can help you to assist them to understand themselves and their decisions better. How can we get overconfident clients to realise that they are without deflating their egos – and why does it matter?
Human decision-making, thinking and behaviour are central to the way businesses, communities, organisations and institutions run. This is why social scientists have always been interested in studying human behaviour.
The understanding around human decision-making has matured. Previously the ‘rational economics approach’ was king, which held that we are smart beings who always act rationally. This completely sidelined the role of psychological issues such as cognitive biases and limitations in decision making.
The last two decades have seen stinging attacks on the rational approach, with scientists producing a great deal of evidence that our decisions are strongly driven by irrational tendencies. The main focus of attention here are the issues of biases. Dan Ariely (2008) defines a bias as a “systematic (non-random) error in thinking, in the sense that a judgment deviates from what would be considered desirable from the perspective of accepted norms or correct in terms of formal logic”.
Perhaps the most intense criticisms of irrational behavior came in the wake of the 2008 financial recession, where we paid a high price for learning that relying on rational assumptions alone, can be dangerous. Even devout rational economists like the worshiped former Federal Reserve Chairman, Alan Greenspan, admitted that incorporating irrational biases would help us develop better models of human decision-making.
In 2013, The Washington Post captured the following.…”Finally, Greenspan stops to drink the waters of behavioral economics, a lively new area of research that has demonstrated that irrational economic behavior is not only widespread but so predictable that it can be incorporated into economic models.”
“I have come around to the view that there is something more systematic about the way people behave irrationally, especially during periods of economic stress, than I had previously contemplated,” Alan Greenspan
Overconfidence is perhaps the most ubiquitous of the biases that affect human thinking and judgement. In his 2011 book Thinking, Fast and Slow, Daniel Kahneman calls it “the most significant of the cognitive biases.”
With overconfidence bias people’s subjective belief in their ability is greater than their objective or actual performance. Those afflicted with this bias may also believe that they are at less risk of experiencing an unfortunate event compared to others. If you asked any manager if they think that are better than the average performance score of managers around the country, you’re likely to get over 95% of them claiming that they are better. This doesn’t make sense considering that we calculate the average score by factoring in both bad and good managers.
Overconfidence has been blamed for, among others, the sinking of the Titanic, the nuclear accident at Chernobyl, the loss of Space Shuttles Challenger and Columbia, and the Deepwater Horizon oil spill in the Gulf of Mexico. A 2008 study showed that overconfidence is a major factor contributing to diagnostic error among physicians.
Overconfidence may also contribute to excessive rates of trading in the stock market, high rates of entrepreneurial failure, legal disputes, political partisanship, and even war. In the insurance industry, overconfidence leads people to neglect insurance cover for highly probable risks like injury or illness, that could prevent them from earning an income.
De-biasing overconfidence is evidently crucial in the financial world.
How do we manage overconfidence with our clients?
- Ask your clients to list counter-arguments for their decisions and push them to consider how they would respond to each of these claims.
- Prompt them to consider alternative outcomes and help customers prepare for any possible repercussions of those unexpected results.
- Use available stats to educate your clients on their risks and demonstrate their tendency to err by highlighting the role of overconfidence.
Supporting your clients with such feedback can help reduce overconfidence and it’s role in biased decision-making, empowering them to make informed decisions and change tack before it is too late.
About the Author
An Applied Behavioural Economist. He offers customized consultancy to:
Corporates, Financial services, Governments and Social entities
Contact: stanford.mujuta@fizambia.com
