Humans have an easier time understanding the world by thinking about things in relative terms. These comparisons help us better compartmentalize our thoughts and benchmark our performance. Relative thinking creates order in a seemingly orderless world. But it can be both productive and highly unproductive since, in addition to thinking in relative terms, we also tend to overestimate how good we are at certain things.
The better than average effect is the tendency for humans to overestimate how good they are at certain things.¹ In other words, we think in relative terms, but we have a tendency to make highly unrealistic relative comparisons. Simply put, we create unrealistic benchmarks and then we underperform them. This leads us to do irrational things, but it can also lead us down the the path of negativity bias where we constantly believe that things are worse than they really are.
Negativity bias is the tendency for humans to focus on bad news as opposed to good news. We focus on things that threaten our well-being rather than those things that can positively contribute to our well-being. Negativity bias served us well when we were in constant danger of being some other animal’s dinner, but it doesn’t serve us as well in a world where life threatening events aren’t the norm.
To overcome these biases I always try to think of things in absolute terms in addition to thinking of things in relative terms. Benchmarking and comparative performance is valuable for many aspects of our lives. But we have to be realistic about how we perform these comparisons. Our tendency to create unrealistic benchmarks often results in failed relative thinking which leads us down the path of negativity bias as we focus excessively on all of our short-comings. Fear and negativity are, by far, the most destructive behavioral biases. Learning how to properly think in relative terms as well as absolute terms is a good starting point for avoiding the negativity trap.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.