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In a book recounting how he became one the world’s richest men, George Soros describes how investor beliefs create market bubbles – illusions of value – that keep on growing, until they ultimately burst, causing a market crash.  According to Soros, market bubbles happen when investors fail to realize that a particular asset (real estate, currency, stock, or whatever) is going up in price, not because of any real value, but simply because everyone’s been buying it.  

A classic example was the real estate bubble that collapsed in 2008.  Easy credit led to increased home buying (demand), which in turn led to higher real estate valuations, which in turn made more people frantic to “jump on the band wagon.”  Another example, even closer to home for Soros, was the rising price of the British pound sterling in the early 1990’s.  Soros saw that the pound was being propped up with borrowed money and was way overvalued.   Realizing this “bubble” would burst, Soros executed a short sale on $10 billion worth of pounds on September 16, 1992, realizing $1 billion in profits in a single day.

In his book, Soros describes an earlier personal turning point back in the mid-1980s, when he decided to confront his own biases by keeping a diary.  In the diary, he would write down his reasoning behind each trade, noting carefully when his predictions worked and when they failed. In this way, he sought to more rigorously test his personal theories and learn to become more objective.  This practice, he believed, prepared him for later trading successes.

The Trap of “Emotional Thinking”

It’s long been known that strongly held values and beliefs can filter and bias our perceptions.  As early as the 1940s, a study by Indiana University psychologist Leo Postman and colleagues revealed that people more quickly recognize words related to their personal values, and make more mistakes when reading words contrary to their values.      

Another way that values and beliefs distort our reality is through the confirmation bias, a tendency to twist and filter facts to make them fit existing beliefs.  One of the best-researched sources of judgment errors, confirmation bias narrows our field of attention to facts, filters out evidence that doesn’t fit existing beliefs, and overweights evidence that does.  Studies have shown that even scientists are susceptible to confirmation bias, prompting them to more readily believe weak evidence supporting established theories, and to suspect that investigators who disconfirm mainstream theories must be using inferior research methods or committing mistakes.

And it’s not just our values and beliefs that bias our judgments.  Recent research reveals that past decisions or actions also create a sense of emotional commitment that greatly distorts our judgments of value – that is, what we believe something is worth.  The simplest example of this is what Cornell’s Richard Thaler calls the endowment effect.  In a typical experiment, people estimate what they would pay for a particular item, say, a coffee mug or bottle of wine.  Then they’re asked what they would accept for the same item if they already owned it and were asked to sell it.  Typically, already owning something causes people to ask several times the amount they would have paid for it.  Thus, it seems that owning a thing strengthens an emotional bond with the item and inflates perceptions of worth.

An especially dangerous form of endowment effect is the sunk cost bias or the “tendency to continue an endeavor once an investment in money, effort, or time has been made.”   In other words, once we’ve spent resources on something – like a losing strategy or doomed investment – we stubbornly hold on to it, even when warning signs are telling us to abandon ship.  Research on thousands of trades at a large discount brokerage house have shown this bias to be a significant source of loss for investors.

Sunk cost bias has effects far greater and more insidious than staying too long with stock market losers. It can also lead to major misfortunes like disastrous military campaigns and overbudget public works projects.  The more lives lost, the more assets expended, the more urgently we feel a need to “stay the course” and justify prior sacrifices.  No one wants to proclaim failure and “pull the plug.”

Sunk cost bias and confirmation bias would not be so dangerous, if we only knew when they were present and could work to counter them by examining evidence to the contrary.  But the problem is that, like barnacles on one side of a ship’s rudder, these biases operate below the surface, steering us off center, without our conscious awareness.  So, people think they’re acting rationally, based on the best available evidence, but in fact, they’re showing what Harvard Psychologist Ellen Langer calls mindless automaticity.  In effect, they’re on “automatic pilot”, acting on emotion and ignoring signals that should make them choose more wisely.  The result is a kind of forced overconfidence that leads to long-term losses.

Overcoming Emotional Thinking

So how do we avoid this automatic emotional thinking that inclines us toward past decisions and warps our view of present options?  To make better decisions, we first need to get off autopilot and pay close attention to all available information, including our own emotional signals.  Like a pilot heading into bad weather, we can’t be mulling over past mistakes or what we’ll say when we wave good-bye to passengers at the gate.  We need to focus on what’s happening right now.

So while our gut feelings may be one kind of signal, we must also pay attention to changing conditions and respond to important information inputs.  For the pilot, this means scanning the horizon, watching instruments, and noting weather conditions in different directions and at different altitudes.  By the same token, investors should be alert to changing market trends and gathering relevant facts for each investment option.  

Now it’s unrealistic to think we can eliminate all forms of bias in our decision-making, but there are some steps to mitigate it, based upon decision research.  These include the following:

1. Analyze and compare multiple options.  Research has shown that people are much better at comparing strengths and weaknesses of multiple options than they are at evaluating a single option in isolation.  So it makes sense to always have at least two alternatives in mind.  This means you shouldn’t just think “to sell or not to sell”, but rather, “If I did sell, is there a better place to put the proceeds?” In other words, your array of options should include at least one solid Plan B.  This is tough to do in practice because it makes the options more balanced and the choice more difficult.  But it’s likely to result in a less biased decision.

2. Before you decide, practice mindful self-awareness.  This sounds like a new age nostrum, but is really based in science.  Andrew Hafenbrack, and his colleagues at Wharton School of Business report a series of four studies on sunk cost bias encompassing almost 500 adults.  In the studies, they found that a 15-minute mindfulness exercise (focused-breathing meditation) enabled more than three quarters of their subjects to resist sunk cost bias in a subsequent decision, versus fewer than half of control subjects who didn’t do the exercise.  Moreover, the mindfulness-trained subjects showed more focused awareness of both the present moment and their own physical sensations.  Self-awareness was also proven to be pivotal in a study of London investment bankers, cited by emotional intelligence guru Dan Goleman. It that study, encompassing four banks, 128 traders and senior managers, everyone used analytical tools.  But the more self-aware traders also attended to a wider array of emotional signals – including their own anxiety – telling them when to invest and when to hold back.  As a result, earnings of the more “mindful” investors averaged five times greater than their less self-aware colleagues.

3. Stay open-minded.  Consult with people who’ll tell you things you don’t already know.  It’s critical to source information about alternatives from range of unbiased providers – people with no stake in the transaction.  To make good decisions, we need good data.  And simply relying on what we already know puts us in danger of sticking with the status quo, the place where sunk cost and confirmation biases rule.  Conversely, to explore new options, we must give up the need for certainty and open ourselves to new inputs.  

It’s natural to feel anxiety and desire closure when facing a big decision, and yet this very tendency to avoid discomfort is what can push us into a bias-land, if we’re not careful.   A helpful attitude during your information-gathering phase is tolerance for ambiguity or the ability to hold conflicting views in mind.  Ambiguity tolerance prevents premature closure and has been found to be hallmark of successful entrepreneurs and investment bankers.   A simple aid in keeping the mind open is to list pluses and minuses (or benefits and risks) for each option.   Feelings, hunches, or intuitions can be included in this list, on whatever side of the ledger they belong.  But the main idea is that by writing everything down – including emotional reactions – we raise awareness and reduce the odds of hidden influences on our choices.

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Readers who wish to learn more about investment decision-making are encouraged to check out this article by Nobel laureate Daniel Kahneman and colleagues, or this very thorough book by Harvard Professor Max Bazerman. Also, you can check out this reading list on Mindful Investing.

During the late 1960s and early 1970s, Stanford psychologist Walter Mischel developed a simple and ingenious test to assess self control and attention in preschool children.  He offered kids in the 3- to 5-year-old age range a choice:  You get this one marshmallow now, or if you wait 15 minutes, you can have two.

Of course, some kids just grabbed the marshmallow and stuffed it in their mouth, while others waited longer before giving in to temptation.  Surprisingly though, about one third of the kids were able to hold out for the full 15 minutes.  These more patient kids occupied themselves by singing or playing until the time was up to claim their two-marshmallow reward.  Mischel found that kids who occupied their minds with happier thoughts about “fun things” held out better than kids who had “sad thoughts” or kids who spent time staring at the marshmallow reward itself.

So why should we care about self control in three- to five-year-olds?  Well, it turns out that a preschooler’s ability to delay gratification (that is, wait for the two marshmallows) was an important predictor of success in later life.  When the kids became adolescents, the ones who delayed gratification longest ended up with higher SAT scores, were rated as more socially competent, more verbally fluent, more rational and planful, and proved better at coping with stress and frustration.  Even more surprising, when these kids grew up and reached their 30s, the two-marshmallow kids were more successful financially and less likely to use risky drugs.

So what can the trait of delaying gratification tell us about becoming better innovators?

Innovators’ Ability to Delay Gratification

Anyone who has done the work of innovation knows that breakthroughs don’t come easy.  A truly novel and useful new product or service is born from the hard labor of many failed experiments, half-baked prototypes, and solutions that were tried, but simply didn’t work.  Short-sighted, “show-me-the-money” people need not apply.  Famous innovators had persistence that was legendary.  Thomas Edison, known for his relentless optimism, famously tested 1600 different materials before discovering carbonized bamboo as the best filament for his incandescent light bulb.  Even more failed experiments were needed to develop his first commercially viable storage battery (used by Edison to power electric cars in the early 1900s).  When asked about how many experiments were needed, he replied, “Goodness only knows! ... We ran through several series—I don’t know how many, and have lost track of them now, but it was not far from 50,000.”  

Sir James Dyson is known as the inventor of the Airblade hand dryer and the Air Multiplier, an odd-looking but powerful fan with no blades.   But he is most famous for inventing the world’s first bagless vacuum cleaner, a project that took him five years and over 5100 prototypes before it was ready to market.

Innovators like Edison and Dyson were able to wait years for their reward – a finished prototype, ready-for-production.  And like the kids who occupied themselves with happy thoughts about “fun things”, these innovators learned to hold onto their ultimate goal, while still enjoying the journey, and the thrill of discovering what doesn’t work, through a patient process of elimination.

Marshmallows For The Corporation

Recent publications by leading business experts have shown that corporate growth through innovation may be hindered by a dynamic similar to that faced by five-year-olds in the Marshmallow Test.  In a June, 2014 Harvard Business Review article, innovation guru Clayton Christensen and colleague Derek van Bever describe what they call “The Capitalist’s Dilemma.”

The authors note that, over the past 60 years or so, the recovery time after each world economic recession has been getting longer and longer.  They attribute this to an increasing reliance of companies upon short-term financial ratios to measure their performance.  For example, ratios like RONA (Return on Net Assets), ROIC (Return on Invested Capital), and IRR (Internal Rate of Return) are all calculated by dividing some measure of income or value (the numerator) by a measure of the capital or expenses invested (the denominator).  These ratios are usually calculated on a monthly or quarterly basis, displayed in spreadsheets, and heavily relied upon by managers in making capital investment decisions.  Financial analysts use these same ratios in grading the performance of a company’s executive team.  The beauty of the ratios is that they all measure efficiency in the use of capital – something that both company executives and financial analysts value greatly.  
 
The problem with these spreadsheet ratios is that they only emphasize efficiency in the use of capital. Executives can improve their ratios and earn gold stars by either boosting income (the numerator) or by cutting the expenses, assets, or resources needed to run the business (the denominator).  A “no-brainer” move to make your numbers look better is to simply cut expenses: outsource customer service and manufacturing, keep your staffing lean, and let other companies do the messy work of making your widgets and dealing with your customers.  

Getting all these assets off the books shrinks your denominator and makes your ratios look great.  And this move is also relatively quick and easy to implement.  On the other hand, you could invest your capital and try to grow the numerator of these ratios by creating innovative new products, new customers, new markets and new sources of revenue.  But that move is much more risky, and takes much, much longer.  Hiring, rewarding, and retaining talented people, giving them time and resources to test ideas, carefully documenting and building upon failed experiments.  These things take years, and meanwhile, your ratios don’t look as good, and your investors are getting nervous and may start asking for “regime change.”  Much safer to invest your capital in short-term efficiency improvements or in buying back company stock to drive up the share price.

This bias for the short-term has led Christensen and van Bever to label spreadsheets as the “fast food of strategic decision making.”  So just as fast food helped to create an obesity epidemic through overconsumption of high-calorie comfort food, management-by-spreadsheet has created an over reliance upon investments in short-term efficiency improvement, undermining the long-term health of businesses.   

The reason why simplistic spreadsheet ratios won’t work for innovative companies is that innovation takes a long time (usually three to ten years) and is unpredictable. Imagine you’re at Apple in 2004, developing your company’s first cell phone.  The cell phone industry is dominated by players like Nokia, Palm, Samsung, Motorola, and Sony Ericsson.  Your company has never made a cell phone.  The dominant players have sold millions of phones and their phones all have button keypads.  The phone you’re developing has a big screen and no keypad. How would you calculate capital efficiency ratios for this new product?  Could you estimate in 2004 the capital needs and revenues streams associated with iPhone’s various future businesses, such as music, movies, social networking, gaming, mapping/navigation, credit card transactions, etc.?

Clearly, simple spreadsheet-ready formulas won’t do the job here.  What’s needed is a leadership team that can see beyond the next quarterly earnings call, has the courage to manage for the long term, and strongly desires to create something new for both customers and their company.  These leaders appreciate how different kinds of expertise are blended in creating a prototype, and how prototypes are tested and evolved through experimentation.  Moreover, if the product requires basic science breakthroughs, leaders may need to monitor many signs and indicators that just can’t be readily quantified.  

Managing for Long-Term Breakthroughs

In recounting their experience leading projects at the Defense Advanced Research Projects Agency (DARPA) Regina Dugan and Kaigham Gabriel mention some of the indicators that helped in leading basic science breakthrough projects.  DARPA, you’ll recall, is the agency famous for basic technology advances that include the Internet, RISC computing, global positioning satellites, stealth technology, and smart “drones.” None of these breakthroughs followed the predictable path of a new product platform extension, like for example, creating a new flavor Pop-Tart. Instead, leaders had to track a wild ride of fast iterations, keep planning light and nimble, and make sure that projects were progressing toward goals.  They needed to study any failures to see if they were revealing dead ends, uncovering new applications, or signaling a need for new types of expertise.

Innovative leaders and their organizations understand the innovation process and how to manage it.  They manage this process for long-term results, in a time frame where manage-by-numbers breaks down.  They commit to long-term goals and value progress more than predictable quarterly results. And they appear to enjoy the process of innovating as much as the reward at the end of the journey.  And thus, like the “two-marshmallow” kids, they make good use of the time spent getting there and in the long term, will be more financially successful.

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Mischel, Walter and Ebbeson, Ebbe (1970) Attention in Delay of Gratification.  Journal of Personality and Social Psychology, 1970, Vol. 16, No. 2, 329-337.

Regina Dugan and Kaigham Gabriel (2013) “Special Forces” Innovation: How DARPA Attacks Problems.  Harvard Business Review, October.

Who could forget the famous scene in Star Wars sequel Empire Strikes Back, when Jedi Master Yoda counsels Luke to use The Force in lifting his X-Wing fighter out of the bog? When Luke complains, “I can’t. It’s too big.” Yoda counters, “Size matters not. Look at me. Judge me by my size, do you? Hmm? Hmm. And well you should not. For my ally is the Force, and a powerful ally it is.” Yoda then proceeds to lift the X-Wing fighter out of the bog, using only the power of his mind. Of course, Luke is dumbfounded, exclaiming, “I don't… I don't believe it.” Yoda counters, “That is why you fail.”

While few of us have “aircraft lifting” in our job description, many of us working in product design and quality improvement are routinely called upon for some “heavy lifting” of our own, with similar intractable problems: Achieving better system performance at lower cost. Completing twice the project work in half the time, or hardest of all, balancing work and personal life so that neither comes up short.

Over the past 20 years or so, psychologists have studied the effects of positive expectations – or in Luke Skywalker’s case, the lack of them – upon creativity and problem solving. It turns out these effects are powerful and pervasive.

Positivity and Creativity    

In a typical positivity-and-creativity study, researchers induce positive emotions and expectations by having people watch a short comedy video or read positive affirmations. The people are then tested for the number of creative ideas they can produce (fluency), originality of new ideas, or flexibility in solving a difficult problem. In a summary analysis of these studies (called a meta analysis) two researchers at Nanyang Technological University found an average performance improvement effect (measured by something called the standardized mean difference statistic) of .43. By way of analogy, if the creativity task were an IQ test, this size of improvement would roughly equate to a performance advantage of six or seven IQ points. Not too shabby for a quick “positivity fix.” So how do we explain this effect?

Barbara Fredrickson, a psychologist at the University of North Carolina, offers one of the best explanations, which she calls broaden and build theory. Fredrickson maintains that positive emotions – such as joy, interest, contentment, pride and love – will broaden receptivity and access to information and personal resources (“thought action repertoires”) from a wide variety of sources all around us, whereas negative emotions – such as fear, anger, disgust, sadness – constrict our awareness to just a few options (“fight” or “flight,” for example).

So for instance, if you’re out for a walk feeling joyful, loving, and confident, you may notice that flowers are blooming, the birds are singing, and children are playing in the yard next door. Conversely, if you’re worried about a snake on the trail, you’ll be alert to snake-like things, but may miss most everything else along the trail.

One other way that emotions focus our attention is their effect on our time horizon. So, while negative emotions sharpen sensitivity to troubles in the immediate time and place, positive emotions attach a “wide-angle lens” to our awareness, helping us to see tools, skills, and resources that will build our store of assets over the long term – giving us a longer view and preparing us for the future.

But what about people who swear that fear of deadlines makes them more creative? Research shows that deadlines actually degrade creativity. In a long term study of over 200 professionals who completed daily diaries of their work activities, Harvard professor Teresa Amabile discovered that people were least creative under time pressure, and in fact experienced a “hangover effect” of lowered creativity up to two days after a deadline – just what you’d expect from broaden-and-build theory.

Positivity and Team Performance

So positive feelings and attitudes give individuals a problem solving advantage, but most of us work in groups. What can positivity do for teams? Research shows the power of positivity in teams as well. Psychologist Marcial Losada and his colleague Emily Heapy observed some 60 business teams in the process of formulating their business strategies. Losada and Heapy analyzed the teams’ conversations using a simple scheme: statements made by team members (called “speech acts”) were coded as “positive” if they showed support, encouragement, or appreciation, and “negative” when the statements were disapproving, sarcastic, or cynical. The ratio of positive to negative comments for each team was then compared with their actual performance results. The results were startling.

The highest performing teams had a ratio of almost six positive comments for every negative. Medium-performing teams were almost two positives for every negative, and low-performing teams were about one-for-one. Researchers also noticed an “atmosphere of buoyancy” in high-performing teams that lasted throughout their meetings. They were having fun! And consistent with the notion of broaden-and-build, high-performing teams spent more time asking questions to generate new information and less time arguing with each other.    

Using “The Force” for Positive Outcomes

For some of us, getting into a positive mood can be a struggle. There are bills to pay, the car is having problems, and I have to deal with that difficult boss/coworker/patient every day. Sometimes it’s tough to get up in the morning and face the day, much less think happy thoughts to gear up for the big strategy meeting.   This very challenge led Martin Seligman – also known as the Founding Father of Positive Psychology – to study people who show the trait of optimism. His work revealed some important things these people did that in turn led him to devise some practical exercises to help the rest of us reap the benefits that optimists seem to enjoy.  

Seligman found that optimists tend to see negative events as more temporary, changeable, and externally caused. So they don’t worry that misfortune is their fate or lot in life. By the same token, in looking for a way out of difficult situation, optimists tend to home in on the more controllable aspects of the situation, and focus their optimism on looking for pathways or breakthroughs in those areas to reach a solution. They remain open to new things and avoid what Seligman called the “learned helplessness” that pessimists can fall prey to.

Some Exercises That Work

In a recent book, Seligman describes two exercises, tested and proven in peer-reviewed studies that create lasting positive changes in mood. The first is The Gratitude Visit, where he asks you to visualize a person who did something that changed your life, but whom you never thanked properly. Next, he asks you to write a letter thanking that person, then visit the person and read the letter to them.

A second exercise entails taking 10 minutes each night for a week to write down three things that went well today and why each of these things went well. (I’ve tried this one and can say that it really works. After a week of this, you really start noticing more and more things that are good about your life and your work, even though problems still happen.)  

Finally, if you’re looking for a fast exercise to prepare for that strategy meeting, you can try a proven approach that creativity researchers – including many of those mentioned earlier – have used to put people in a positive mindset. It’s called the Velten Mood Induction (not to be confused with the Vulcan Mind Probe), takes about 10 minutes, and entails reading 58 short affirmations.

Good luck, and may The Force be with you!