It’s fairly well known that many of our investment decisions, indeed many of our financial decisions full stop, are not entirely rational. Could some of the biases that prompt our financial investments to go astray also provide us with some lessons on how to manage innovation more successfully?
After all, both fields deal with an uncertain future and force us to trade off between short and long-term goals. Whilst the classical, and rational, economic man would make wholly sensible decisions on such things, the reality was often a whole lot fuzzier, which has sparked the rise in behavioural psychology.
With behavioural finance attempting to remove some of the biases that distort how we invest, can these insights cross over into our innovation decisions? Lets look at four particular pitfalls investors make that have been explained by our new behavioural understanding.
- Failing to invest – One of the more well known examples of behavioural psychology chronicled in Nudge was an attempt to improve our willingness to save for retirement. Around the world workers and policy makers have struggled with the challenge many face with saving now for a future that is far away. A pension is a very rational investment, yet investment still lags behind what is recommended. The primary reason for this is loss aversion, ie they are more aware of what they lose than what they gain.
You can see this when you try and change something, because people are scared of losing the status quo. So what can you do? The retirement situation was challenged by automatically enrolling people onto schemes, so they’d need to actively opt-out. With innovation, perhaps you could try committing to a specific R&D budget for the next few years, and communicate this widely so it can’t be welched on.
- Dawdling on decisions – When you’re looking to invest, the choice of stocks, funds and all of that is pretty overwhelming. If there isn’t an easy, default option,then it’s easy to procrastinate and avoid making any kind of decision.
When it comes to innovation therefore, you want to do all you can to make it the default option. This involves building a culture whereby innovation is integral to all that you do.
- Focusing too much on details – The key to successful investing is having a strong portfolio. This allows you to hedge the risk of one or two bad investments and prevents you focusing too heavily on individual stocks and more on the portfolio as a whole. That’s the rational approach anyway, which is not always what investors do. So poorly performing stocks get held onto in the hope they’ll rebound, which they seldom do, and the losses rack up. In psychological terms this is a combination of loss aversion and the endowment effect, which respectively cause us to worry excessively about registering a loss and also valuing what we own too highly.
All of which makes it hard to see the wood for the trees. You can often fall into the same trap when innovating, with a focus on how much you have spent on projects and a reluctance to write them off and re-focus elsewhere. It becomes what’s known as an escalation of commitment.
Instead, treat your innovation projects as a portfolio so that you can easily allow failing projects to cease and invest afresh into more promising endeavours. All with the crucial performance of the portfolio as a whole in mind. A portfolio based approach would also allow you to provide a variety of risk throughout your projects.
- Doing what you’ve always done – With much in life, there is often a tendency to stick to what we know. For instance, most investors favour stocks from their own country. Data suggests that 87% of American portfolios consisted of US stock. When investing, awareness of this bias can be enough to prompt as much diversity as possible in ones portfolio.
When innovating, this fallacy is typified by the not invented here syndrome. Utilizing things such as open innovation can be a great way of overcoming this fallacy as it doesn’t necessarily require you to actually identify external sources yourself, as they tend to be attracted to you instead.
There are many more psychological biases that may impact our ability to innovate effectively, but these should give you a start in applying behavioural thinking to your own attempts to innovate well.
