Cognitive Dissonances
Lesson summary:
The lesson explores how motivated reasoning can be used to reduce cognitive dissonance, enabling individuals to maintain a desired physiological or psychological state and avoid the stress of change. Cognitive dissonance occurs when our actions or beliefs contradict each other, leading to discomfort. To resolve this discomfort, we might resort to motivated reasoning, where our reasoning process becomes subordinate to our desired conclusion, allowing us to maintain our behaviour even when evidence suggests it may be harmful.
For example, consider someone who enjoys smoking, despite knowing the health risks. They may engage in motivated reasoning by focusing on outlier cases of people who’ve smoked their entire lives without apparent health issues, while ignoring the overwhelming evidence that links smoking to numerous health problems. This allows them to reduce cognitive dissonance, continue enjoying their habit, and avoid the stress of quitting.
How Cognitive Dissonances applies to investing and trading:
Motivated reasoning can similarly affect decision-making in investing and trading. An investor might hold shares in a company whose business practices they morally object to. To reduce the cognitive dissonance of profiting from a company they disapprove of, they might resort to motivated reasoning. They might focus on the company’s philanthropic activities while downplaying or ignoring their unethical practices.
For instance, an investor could own shares in a company with a track record of environmental negligence. Even if confronted with evidence of the company’s negative environmental impact, they may choose to focus on the company’s CSR initiatives or greenwashing campaigns. They could convince themselves that the company is making positive changes, thus avoiding the stress and potential financial loss associated with selling their shares. This selective reasoning can lead to unwise investment decisions, as it disregards important evidence about the company’s long-term sustainability and potential for reputational damage.