Netflix (NFLX) is a company which lets subscribers watch movies on their television, computers and mobile devices. Take a look at its stock chart for the last 3 years.
In Aug 2012 the stock was selling for around $53. On July 19th 2013 it is selling for $264.58. In less than 1 year the stock went up by 5 times. Looking at the price today most of us will think why did I not see the obvious. If I had invested $10,000 I could have easily made $50,000. I have done this several times and I have seen most of my friends doing this over and over. This is a classic example of hindsight bias. Wikipedia defines it as
Hindsight bias, also known as the knew-it-all-along effect or creeping determinism, is the inclination to see events that have already occurred as being more predictable than they were before they took place.
Why does this happen?
In Thinking Fast and Slow – Daniel Kahneman writes
A general limitation of the human mind is its imperfect ability to reconstruct past states of knowledge, or beliefs that have changed. Once you adopt a new view of the world (or any part of it), you immediately lose much of your ability to recall what you used to believe before your mind changed.
The hindsight bias will be very high when the consequence is worse.
In the case of a catastrophe, such as 9/11, we are especially ready to believe that the officials who failed to anticipate it were negligent or blind. On July 10,2001, the Central Intelligence Agency obtained information that al-Qaeda might be planning a major attack against the United States. George Tenet, director of the CIA, brought the information not to President George W.Bush but to National Security Adviser Condoleezza Rice. When the facts later emerged, Ben Bradlee, the legendary executive editor of The Washington Post, declared “It seems to me elementary that if you’ve got the story that’s going to dominate history you might as well go right to the president.”
On July 10, no one knew – or could have known – that this tidbit of intelligence would turn out to dominate history.
In the field of software development hindsight bias happens a lot. Bugs in software is quite common. Most of them are minor and some of them end up being major. Recently we encountered a production issue, which made a piece of functionality inaccessible for a couple of days. The root cause of the problem was found and the issue got fixed. After the root cause was found one developer made the following comment.
The bug was so obvious and why did the developer not see this while coding.
Of course the issue is obvious after we know it. During coding this was not obvious.
India vs Sri Lanka 1996 world cup semifinals
Do you remember the 1996 world cup semifinals between India and Sri Lanka at the Eden Gardens stadium? India won the toss and put Sri Lanka into bat. I was surprised by the decision. But I was quiet because the outcome is not yet known. When Jayasuriya and Kaluwitharana got out after scoring only 1 run, I was very happy. I justified why putting Sri Lanka into bat was the right decision. In fact I was not the only one. Sri Lanka went on to scored 251/8 in 50 overs. India chasing 252, lost 8 wickets and scored only 120 runs in 34.1 overs. The crowd interrupted the match and the match was abandoned. Sri Lanka was declared as the winner.
What happened after that? I blamed the decision of putting Sri Lanka into bat as the cause for losing the match. With in few hours I changed my decision based on the outcome. In fact I was not the only one the whole country was in rage because of that decision. After the match the captain of the indian cricket team, told
It was a team decision which was taken by all the team members that when we win the toss we will field.
Daniel Kahneman calls this as outcome bias.
When the outcomes are bad, the clients often blame their agents for not seeing the handwriting on the wall – forgetting that it was written in invisible ink that became legible only afterward.
Focus on the process and not on outcomes
Always focus on the process and not on the outcomes. Why? We do not control the outcomes. Having a solid process will increase our odds of successful outcomes. Robert Edward Rubin is an American economist and banking executive. He served as the 70th United States Secretary of the Treasury during both the first and second Clinton administrations. Before his government service, he spent 26 years at Goldman Sachs, eventually serving as a member of the board, and co-chairman from 1990 to 1992. In the book The Halo Effect the author writes about Rubin’s experience at Goldman Sachs
One memorable deal was the proposed 1967 acquisition by Becton Dickinson of a rival company in the medical products industry, Univis. Under the terms of the stock swap merger, one share of Univis would rise from its current market price of $24 1/2 to about $33. When the deal was announced, Univis shares rose on questions – about whether the deal would come to pass. That was the question Rubin’s department had to answer. If Goldman Sachs believed the merger would succeed, it would buy Univis at $30 1/2 and enjoy the further rise to $33; but if it expected the deal to fall through, it might sell Univis short. After much calculation, Goldman Sachs bought shares in Univis. It stood to gain $125,000 if the merger went through, a tidy chunk of change in 1967. But some weeks later, a disappointing earnings report at Univis caused Becton Dickinson to withdraw its bid, and Goldman Sachs ended up losing $675,000-more than five times what it had hoped to gain. Naturally there was a fair amount of second-guessing and finger pointing along the corridors of Goldman Sachs, a normal reaction since many people infer that a bad outcome is the result of a bad decision. But even though the result turned out badly, Rubin knew the decision hadn’t necessarily been wrong. He explained: ‘Even a large and painful loss doesn’t mean that we had misjudged anything. As with any actuarial business, the essence of arbitrage is that if you calculate the odds correctly, you will make money on the majority of deals and on the sum total of all your deals. If you take a six-to-one risk, you will lose money every seventh time. To an outsider, our business might have looked like gambling. In fact, it was the opposite of gambling, or at least of most amateur gambling. It was an investment business built on careful analysis, disciplined judgments often made under considerable pressure and the law of averages.” As a veteran of deal making at Goldman Sachs, Robert Rubin knew that roughly one deal out of seven was likely to go bad. He and his colleagues tried to improve their success rate, sure, but they knew from experience that one loss out of seven was likely and acceptable. If the loss rate went much lower, it might signal that Goldman was not taking enough risks, which would also be a serious problem. The optimal rate of failure wasn’t zero, any more than the optimal number of defaults on banks loans is zero. Just make sure that one loss doesn’t break the bank! This view of the world is based on an appreciation of probability.
Is there a solution?
Any time you are faced with a situation to take a major decision in life – Daniel Kahneman recommends that
You should go down to the local drugstore and buy a very cheap notebook and start keeping track of your decisions.
Why? In future if you want to know under what circumstances this decision was taken, you can go to the notebook and get the information. This way you can avoid the hindsight bias.
Before the start of every year, I write down the goals that I want to achieve for the next year. I called this as yearbook. I started doing this from Dec 2007 onwards. This is what I wrote on 1st Dec 2007 on why am I writing this yearbook.
Why am I writing this yearbook
This is required to keep track of all our financial, career and health goals. Human brain is very powerful and sometimes funny too. Whatever I wanted to achieve I have achieved it. But since I have not tracked it anywhere my brain thinks that I did not do anything. Hence I decided to keep track of our
4. Any other goals
When I wrote this in 2007 I never knew about hindsight bias. Keeping notes this way helped me a lot in avoiding the hindsight bias. In hindsight it makes sense!