What is... | July 21, 2016

What is action bias?

We often prefer doing anything instead of nothing, but our bias for taking action can cause trouble with our finances.

Have you ever sat so long in traffic that you decided to take another route, only to waste more time (not to mention petrol) than you would have if you’d waited patiently in the first place? Yet it can feel so satisfying to take action, instead of doing nothing.

Our natural human bias is towards taking action – doing anything even if there’s no real benefit. This tendency has been documented in research: football goalkeepers, for example, typically jump left or right to defend their goal, even though it has been shown  they are actually more likely to intercept the ball if they stay near the centre of the net.

Should you risk it?
With personal finance, taking action whenever things change can be a high-risk approach, as research comparing the gains made in active versus passive investing makes clear. One well-known 2009 study by Eugene Fama at the University of Chicago shows that the returns made by actively trading shares can easily be swallowed up by the costs incurred when making the trades.

And research from the Wharton school at the University of Pennsylvania, shows “actively” trying to pick the right shares often fails, so even large investors can do best taking a largely passive approach.

Positive procrastination
As economist Chris Dillow writes, it can be good to do nothing. Share markets go up and down – and it is very difficult to buy and sell to take advantage of the moves. Many people do too much trading. They believe they can play the market to win – but cannot.

Savings are another example of how doing nothing can help finances. Putting aside small amounts of money consistently means the sums can really add up over the years – helped along even further by compound interest.

When to do nothing
Of course, if no one ever paid attention or took action on anything, the result would be a complete loss of control over events. Often, something must be done: the trick is knowing when to take action and when to wait and do nothing. This is usually about the degree of clarity of the situation in question. When considering your next move, ask yourself: “Do I understand all the important aspects of this situation?”

If the answer is “no”, perhaps don’t do anything. Time spent waiting, rather than acting, need not be wasted. Thinking about what seems to be really happening can help you make a better decision – one that is more likely to work out well.

At least do no harm
In complex situations, where a lot of different things are happening at the same time, decision making can be especially difficult. Sometimes, though, a “good default” choice will be available – this means setting a low-risk course automatically which will do the least possible damage to your goals.

One example might be setting up bank accounts to ensure the minimum amount is paid on a debt each month. This may not be the fastest way to pay off a credit card or other loan, but it is easy to do and ensures you don’t miss a payment, minimising the chance of additional charges.

Some behavioural economists, including Gerd Gigerenzer, note that following established rules of thumb – or heuristics – can also help beat complexity in some situations. An example might be subtracting your age from 100 to find out what proportion of a portfolio to devote to relatively “safe” versus higher-risk assets.

When to take action
As productivity blogger Francisco Sáez explains, often the best approach can be to let events pass you by and wait until a situation is clear. It is important to reflect on the evidence available before making choices, he notes. Many people, including some business leaders and self-help experts, often argue it’s better to take action and show initiative instead of doing nothing. But sometimes this can be far from the truth.

eZonomics team
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