Lesson 3 of 7 · 14 min
Belief perseverance II: representativeness, illusion of control and hindsight
Representativeness classifies new things by how familiar they look, illusion of control overstates how much we can steer outcomes, and hindsight rewrites the past as predictable; each keeps a comfortable belief alive and each has a practical antidote.
In short
- Representativeness bias: classifying new information by resemblance to past experience. Two forms: base-rate neglect (ignoring how common an outcome is in the wider group) and sample-size neglect (treating a small sample as representative).
- Fix representativeness by asking how likely it is that the investment belongs to the group it resembles versus the group it statistically belongs to, and by collecting base rates or a larger sample.
- Illusion of control bias: believing you can influence outcomes you cannot. Leads to under-diversification, excessive trading and overly detailed models.
- Fix illusion of control by remembering that investing is probabilistic and by seeking contrary views (what could go wrong, when will I sell?).
- Hindsight bias: seeing past events as predictable and remembering one's own forecasts as better than they were. Leads to overestimating predictive skill and unfair judgements of managers.
- Fix hindsight by keeping written records of decisions and reasons made at the time.
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