Don’t ignore great investments

When my father taught me to drive, he always reminded me to check my blind spot. I’m sure most of you received the same advice. All cars, no matter how many windows, tend to shroud certain parts of the driver’s field of vision, which, if left unchecked, can lead to disaster. In academic circles, we call these biases — and they’re hazards to investors as well as drivers.

Our minds, inundated with more information than we can process, take cognitive shortcuts. These shortcuts let us use intuition in addition to reasoning when making decisions. But intuition is also where people’s biases come out—they adopt a point of view based on a partial perspective. And this perspective, often shaped by historical experiences and beliefs, influences future judgements.

For instance, as a venture capitalist, I don’t invest in service businesses, such as travel agencies or accounting firms. In my experience, service ventures don’t scale (in other words, they can’t grow revenues while keeping costs the same) and thus won’t be able to generate the 10-times returns I require to buy in. I won’t even take a meeting to discuss funding a service business. But by taking this position, I may be closing myself off to potentially rich opportunities (e.g., something like Groupon, the discount deal of the day website, which is a service business); my bias prevents me from making an unprejudiced consideration of service ventures, and I have to remain aware of that.

Bias by type

Some biases serve investors well, others less so. But by simply being aware of them, you are less prone to be affected. Here’s what to be on the lookout for:

• Confirmation bias, or willful blindness, occurs when you’ve invested lots of time and energy into reaching a decision. It creates a tendency to highlight situations and facts that confirm your position, and overlook or refute those that undermine your point of view.
• Selection bias occurs when you chose a small, non-random sample of companies to judge a given investment class. So, if I only look at Google, Facebook, Microsoft and Apple, I might think all technology companies grow to billions in revenue within a decade.
• Availability bias, or black swan bias, is the tendency to over-generalize from the facts on hand. Black swan refers to a very rare event (ever seen a black swan?) to assume some other occurance will never take place. But just because you don’t have evidence of a rare event when you make a decision, it doesn’t mean it can’t happen—or that there were no warning signs.
• Commitment bias relates to non-recoverable monies spent to date, also called sunk costs. The more you put into a project, the harder it becomes to be critical. Imagine you finally bought the car of your dreams after endless research, trips to the dealership, and a large outlay of cash. No matter what people say, nothing will dissuade you that isn’t the best car on the market; even if it lives in the shop.

You may feel these predispositions don’t apply to you; that you’re not like others who’ve become prejudiced by past actions. That’s a good sign you’re suffering from the bias blind spot.

Sean Wise teaches entrepreneurship at the Ted Rogers School of Business Management, Ryerson University.