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The Enemy Within: see the world as it is, instead of the world you want to see

The greatest danger to investors comes from within. Because humans have cognitive pitfalls and they always will.

These biases make it difficult to make robust investment decisions and, to make matters even harder, we are also subconsciously influenced by group dynamics. However, there is another way. Plenty of tools have been developed to solve this problem, making structural improvements to decision-making processes within a group.

That’s the message Stefan Lundbergh, director of Cardano Insights and one of the authors of the whitepaper The Enemy Within wants to spread. That enemy from the title is our human nature, Lundbergh explains. "We constantly make decisions in uncertain circumstances, whether it’s in the family, a team at work or the board of a company. Usually, our decisions are not perfect or economically rational, because of the biases that are part of who we are. We have to embrace them, because they’re also responsible for valuable things like love, happiness, creativity, entrepreneurship and, accordingly, innovation and progress. Those same biases, though, can also work against us. That’s why we need processes that can help us deal with cognitive pitfalls and group dynamics. This is difficult for individuals and entirely impossible for the financial world as a whole because of the enormous amount of interaction within it, but for companies and institutions it’s quite easy to implement structures that curtail biases and group behaviour. The Enemy Within offers executives these tools by detailing 8 practical building blocks”, says Lundbergh.

Neoclassical theory fulfils our need for control

In its essence, this whitepaper is about seeing the world as it really is, the author tells us. "Instead of seeing the world as we want it to be. This dilemma is pictured perfectly in the 1999 movie The Matrix, in which the protagonist has to choose between continuing to live in a comfortable illusion built from biases and living in the world as it really is. We all have that choice, and we have to be aware that biases always conjure up stories to protect our ego. We have a natural dislike for uncertainty and ambiguity, which is also why we love seeing causality: if I do x, y will happen. We want to be in control of our organisation, of our future, which is why we make up stories about how the world works. They make us feel good, because they give us a way to deal with our biases. Neoclassical economic theory fulfils all these needs, because it gives us something to believe in by extrapolating the story to the unknown. We simply don’t have enough information about the future, so we make assumptions about it. When extrapolations turn into beliefs, however, theory becomes dangerous, because you stop challenging your own convictions.”

Many stories are not based on facts

According to Lundbergh, this is how a great many stories crept their way into economics despite the fact that they’re not based on facts, on how the world actually works. “A quote from American physicist and Nobel laureate Richard Feynman accurately describes the problem. ‘It doesn't matter how beautiful your theory is, it doesn't matter how smart you are.  If it doesn't agree with experiment, it's wrong. This is where the real challenge lies, especially when you start acting as if the model were really correct. Many economic theories are very suitable as study material and thought experiments, but if we base financial policy solely on theories, we’ll be fooling ourselves.”

Even the smartest people make the silliest mistakes

It takes humility to see the world as it is, says Lundbergh. “People with a big ego are especially prone to holding on to their stories. In the words of Churchill: 'However beautiful the strategy, you should occasionally look at the results.' Once you’re willing to see the world as it is, you’ll need tools to make better decisions in an uncertain world, which you can use to avoid biases and group dynamics as much as possible. We have to accept that biases are common to all and that even the smartest people make the silliest mistakes. The good news is that there are tools you can use to ‘de-bias’ and make structural improvements to the decision-making process. We discuss several of them in The Enemy Within.”

You have to be humble and adaptive, you have to be prepared to keep challenging your convictions.

However, Lundbergh also warns that these de-biasing tools for improved decision-making should not be considered a panacea. “Implementing them during your board meetings won’t guarantee automatic success. The world is uncertain and unpredictable and even the best approaches can fail. On the other hand: the more robust your solutions, the better your prospects, no matter what the future holds. The more you use these tools, the more practice you get in applying them. To deploy these tools successfully, though, we also need diversity of thought, which means that, in addition to an open mindset, your board should also boast many different ways of thinking. It is in our nature to prefer dealing with like-minded people and to hire clones, which means that the only way to realise diversity is to actively pursue and promote it. Furthermore, you have to be humble and adaptive, willing to keep challenging your convictions. You’ll find that it’s an ongoing process that keeps getting better and better, but the minute you stop, biases and group dynamics will return in full force.

The road to better decision-making

The Enemy Within. Making better decisions by challenging your own convictions is a Cardano publication. This 100-page XL whitepaper examines the way our brain works, before looking into personal biases and group dynamics and, subsequently, their innocent and dangerous consequences. These chapters are packed with evocative descriptions of scientific experiments and many more faits divers. What follows is a list of tools that executives can use to de-bias the road to better decision-making in a pension fund boardroom. This is done by means of eight building blocks and a checklist aimed at preventing avoidable mistakes.

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