The Illusion of Control

You've seen this scenario in a dozen movies and TV shows. A group of con men want to extract a large sum of money from a wealthy victim. So, they set up a poker game. Early on they let their "mark" win. As his chips pile up, so does his belief that he can't lose. When his confidence is at its peak, the con men shift the game. They gradually win all their money back plus all the money they were hoping to get out of their victim. Technically, they haven't robbed him, because he willfully continued playing. The reason this strategy works is because once somebody believes they are skilled at a game of chance, they are far more likely to stick to their "winning strategy" long after the evidence shows it's not working.

There's actually scientific evidence for this early success trap. Researchers call this mistaken belief that you can predict random outcomes the "illusion of control." To test for the prevalence of this fallacy, Harvard psychologist Ellen Langer ran a series of experiments where test subjects were involved in games of random chance.¹ These were activities like picking lottery numbers and guessing coin flips, where neither skill nor knowledge could improve performance.

In the tests, Langer and her team would not let the test subjects see how well their guesses performed. Instead, they told them their outcomes. In this way the researchers could give some subjects the illusion that they were on an unusual winning streak. 

Predictably, some of those who were told that their guesses were above average came to believe that they possessed a special skill in predicting the outcomes. However, this belief was far more prevalent among those who had experienced beginner's luck. For example, being told they had correctly guessed the first six coin flips. Those who were told they had a streak of correct guesses at the end of their series had the same belief in their skill as those whose performance was average.

This belief that you can somehow get good at predicting coin tosses is completely illogical. You could toss a quarter 500 times a day as well as study the physics of how small metal disks move through the air, and you will be no more likely to correctly predict a coin flip than a toddler.

Unfortunately, this illusion of control is what leads many speculators in stocks, crypto, and other unpredictable assets to pile up catastrophic losses. They come to believe that they are above average at predicting prices and so they are sure to gain everything back if they just stay in the game. Much like the “mark” in our poker game scenario. Many investing "systems" that appear to succeed during extended bull markets, where many assets are trending upwards, can give the illusion that they will work under more adverse market conditions.

The best strategy is broad diversification. This allows you to participate in potential growth while mitigating the risks often encountered in concentrated or speculative positions. We’re committed to working with you toward your long-term plan, giving you the proven advantages of accountability, knowledge of investor life-stages, and appropriate adjustment for risk.

 

 

1. http://go.pardot.com/e/91522/ns-the-key-to-success-91212539/97162l/2965730219/h/RDDttoyJTXGHrXbPeN87RjU9vXG7Q8KpV4s9uLvjEZM