Have you ever found yourself pressing an elevator button multiple times or with greater force? Have you ever found yourself blowing on a pair of dice or standing up for your team’s attempt at a winning play? In these examples, our actions have no effect on the outcome but we still feel like we have some influence on the situation.
In the 1970s, Ellen Langer ran a series of experiments showing that if you introduced some non-chance task into a random event, you could create an illusion of control. In one experiment, a subject and an actor took turns drawing from a fair deck of cards. The high card would win and the subjects could bet money on each turn. Subjects who were up against an awkwardly dressed actor would consistently bet more than subjects who were up against a professionally dressed actor.
In another experiment, subjects would pay more money for a lottery ticket if they could choose the numbers rather than have them randomly assigned. In yet another experiment, subjects were shown to be more confident in their ability of predicting a coin flip when they were more successful in the past.
Illusion of Control Bias
In each case above, subjects where suffering from an illusion of control. We tend to overestimate our ability to control events which we have no influence over. We infer causal connections where none exist and we use those connections to confidently predict the unpredictable.
This sense of control can be useful – it gets us up in the morning, it allows us to set goals and make plans, it even allows us to ignore the chaos of the universe.
However, the illusion of control is not conducive to sound decision-making. For example, studies have shown that managers who feel higher degrees of control are more likely to escalate a failing strategy – “There’s nothing we can’t make work”.
In investing, we feel that we have more control over the outcomes of our investments than we do. This causes us to trade more than is prudent and to diversify less. Why not put all our money in a company where we feel we have the most control. In reality, successful investing is a probabilistic activity. Even the most powerful and well known investors have little control over the outcome of an investment. Just look at the SunEdison or Horsehead Holding bankruptcies.
The market, like the universe, is a highly complex and adaptive system. All we can do is position ourselves so that the odds are in our favor. We should never think success is guaranteed.
In both life and investing, success is often the result of factors outside our control. When everything is going our way, this idea gets clouded and we start to take outsized risks. The opposite occurs when everything seems to be going against us. In both cases, we would do better to keep the rational side of our brains engaged.