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In Part 1, we examined why and how rare events affect success and failure. In Part 2, we discussed some ways in which we fail to understand and anticipate randomness. We’ll now look at why we have such trouble comprehending randomness, and how our brain’s wiring makes it difficult for us to understand probability.
Overall, these reasons include:
The first reason we fail to properly anticipate randomness is that we are guided by our primitive brain. To aid our survival, our brains evolved shortcuts of thinking that allow us to react quickly and decisively to threats. We’ve evolved these shortcuts to save ourselves time and mental energy; if we were to stop and think thoroughly about each interaction we have throughout the day, we would either miss opportunities or succumb to threats.
For most of our history, this system worked: Our lives were localized and simple, and we could optimize our survival without accounting for rare events. Unfortunately, in today’s complex world, we need to calculate probabilities, and our brains’ shortcuts lead us to believe many things without fully thinking them through. Consequently, we find ourselves equipped with primitive tools to face our contemporary challenges, and our views of the world are often based on misunderstandings and biases we unwittingly hold. A few of these are outlined below.
Neurologists observe that the human brain has developed into three general parts: the primitive brain, the emotional brain, and the rational brain. The rational brain acts as an advisor, but it’s the other two parts—primitive and emotional—that are responsible for decision-making.
This is not inherently a bad thing. Our thoughts can advise us, but without a feeling to direct us toward one option or the other, we get caught in endless rational deliberations as to what’s the best course of action. This can be seen in patients who’ve had brain trauma that destroyed their ability to feel emotions but left them intelligent, making them completely rational beings. People with this sort of brain damage cannot make decisions even as simple as whether or not to get out of bed in the morning.
The negative side of this, of course, is that emotions can steer us wrong and cause us to make mistakes. Emotions can cloud our judgment by blocking out rational thinking and causing us to wrongly assess risk, thereby leading us to make poor decisions. For example, we might buy a particular stock because we love the company and get emotionally invested in its future, though it may not be financially wise to do so.
Feelings also steer us wrong because people are more emotionally impacted by negative events than positive ones. This means they also view volatility much more starkly when it involves lower prices than when it involves higher ones. Likewise, volatility during negative world events is seen as worse than volatility in peaceful times. For example, in the eighteen months leading to September 11, 2001, the market was more volatile than in the same period after, but people gave the later volatility much more media attention. As a result, people are more likely to make moves during times of stress, even if those moves are not strategically wise.