There is a vast literature on the various psychological traps that particularly, but not only, investors fall into, ranging from buying in euphoric booms, to hindsight bias, neglecting probabilities and oversimplifying.
Such cognitive bias certainly constrains effective investment, leading to poor and even irrational decisions.
Furthermore, such errors are made not only by private investors, but also by professionals and by the sellers in their various shapes and forms.
That this all poses serious threats to the industry as a whole is clear enough. But these psychological processes, which also extend to any business and so many other situations as well, tend to be underrated and insufficiently understood.
Further insights can thus be gained by considering the nature of and extent to which business people in the broadest sense can be expected to behave rationally.
A new book on The Illusion of Rationality (Die Illusion der Vernunft) by German neuropsychologist Philipp Sterzer reveals some disturbing mental realities that are in fact essential to understanding the world of business and its various protagonists and players.
The book is complex and so are the issues, such that this article can merely convey the essence of a range of related psychological problems that are fundamental to business and indeed any dealings with other people.
Are we all crazy?
The book itself is quite general in nature, but the neuropsychological approach applies directly and powerfully to the financial and economic context, and has certainly enriched my own understanding of what I have studied, taught and experienced over the years.
After all, if the question Sterzer raises is even partly correct, this affects financial matters radically: “Are we all crazy?”.
While this generalisation is certainly and deliberately way too strong, it does seem the case that many people are totally convinced about things that have little to do with reality.
And this may have nothing to do with honesty and integrity either, but result from something dysfunctional in the brain and its thought processes.
Sterzer points out that it is not only conspiracy theorists or religious fundamentalists who behave in this manner, but potentially anyone and everyone.
Even scientists and by implication analysts and economists, whose very job it is to portray as realistic a picture of the world as possible on the basis of data and facts, may get carried away with enthusiasm or other emotions and produce outlandish, misleading theories and prognoses.
As for the military and political contexts, the less said the better. And closer to home, at the time of writing, I observed an irrational driver risk a head-on collision with another car, rather than slow down for a turning cyclist (me) who had the right of way.
