close
Business
close
Investor's Psychology

What is Heuristics? How does Heuristics influence Decision Making ?

Created on 16 Sep 2020

Wraps up in 6 Min

Read by 10.2k people

Updated on 11 Sep 2022

Have you ever thought about how you are so quick while making some decisions and take time while making some others?

Say, for example, waking up for the office, getting ready, or maybe following a morning routine. All these decisions are in automatic mode, while decisions like investments take time. These are known as Heuristics. 

Daniel Keniman first described heuristics and said that one part of your brain is working while choosing these kinds of automated decisions. These decisions may result from the choices you make in your daily life, which are routine decisions, or they may be a result of different kinds of experiences. 

Heuristics form a vital part of decision-making, which you, as a consumer or an investor, might be unaware of; still, big businesses are using heuristics very well to increase their sales. 

Any individual involved in making financial decisions identifies that he or she is following a specific heuristic while taking any decision, which sometimes might lead to a wrong conclusion. If you understand your pattern of doing things, then you will be able to modify it, or you will be more conscious while taking such decisions or whenever such a situation will occur in life.

What are Heuristics?

In simple words, a heuristic is a problem-solving approach. That implies using practical, easily available solutions to achieve the goals. Heuristics allow people to use quickly available information, which one may derive from experience and help in decision-making and problem-solving.

In psychology, this term is explained as simple, efficient rules that have been derived from how people make decisions or solve complex problems. Some examples of Heuristics include using the rule of thumb, guesswork, intuitive judgments, gut feelings, or common sense. The most common method of using Heuristic is a trial-and-error approach. It can be used in any kind of situation, simple or complex.

If people have difficulty understanding a problem, they try drawing a picture in the form of a flow chart to understand it. If a problem is too complex to arrive at a solution, sometimes we do backward calculations and try to come up with a solution. In the case of abstract problems, we try to relate to some concrete examples.

How can Heuristics help you in making decisions?

Heuristics are very useful for us, as we take thousands of decisions in our day-to-day lives, from various available alternatives. Many such decisions are very routine, and some have to be chosen between multiple available options. 

So these heuristics help us to make quick decisions that are customary or which can be derived from our experience.

  • Heuristics help in decision-making: To solve a problem or make a decision, we often turn to these mental shortcuts when a quick solution is required. The world is full of information, yet our brains are only capable of processing a certain amount.
  • Decisions can be taken with ease based on heuristics: For example, suppose you have to make a decision about the means of transport you are going to choose for your office purposes. In that case, you might recall the route where there is more traffic due to maybe any road construction, and then you immediately decide to choose the other alternative road or try to leave early. 

Thus, in simple words, heuristics allow us to come to solutions quickly.

Types of Heuristics 

1. Availability Heuristics -

Do you know why movies and serials on television are flooded with advertisements? Marketers try to make a long-lasting impression on our minds; because they know that anybody around the world may be entering into a purchase decision, so they make use of availability heuristics to feed the most recent information in your mind.

Now you might have a question: what is availability heuristic?

It is a mental shortcut that helps us make a decision based on natural and quick ideas that come to mind. In other words, we often rely on something which comes to our mind first or is most recent and is easily recallable while making a decision. 

So, when we are involved in decision-making, we sometimes end up judging those events that are more frequent than others because they are available on the top list of our memory. So it might seem to you that those outcomes are common.

For Example, you plan to travel to some other city or country, and you book tickets to go on an airplane, but you remembered a plane crash recently. This news might affect your decision to travel by air as you might feel that air travel is dangerous.

Though the availability heuristic is handy as it helps us decide with minimal availability of information, the availability Heuristic might also lead to some wrong decisions or assumptions. For example, After seeing news reports about people losing their jobs, one might start to believe that his career is also in danger.

2. Representative Heuristic -

Representative Heuristic makes use of the most representative memory and tries to compare it with the present situation for making decisions. 

For example, you saw an older woman. She may have the personality of a sweet woman like your grandmother, and you immediately assume them to be kind and gentle. So there's this perpetual image that we create in our mind that plays a role because we try to relate it with something which comes from our memory.

There are two determinants of representative Heuristic:

  • Similarity: When we judge some new event or person, we usually pay attention to the degree of similarity or repetitiveness and the standard process they have. It is also essential that those features need to be salient. 
  • Randomness: When things are irregular and do not follow any sequence, and there is randomness, then they affect judgment under the representative Heuristic. 

3. Affect Heuristic -

Affect Heuristic is when we are affected by emotions or emotional responses while making a decision. So this Heuristic allows people to make decisions based on their current emotional state, be it happy, sad, surprised, or fearful. Depending upon that, your emotions play a significant role when you make a decision process.

We all have those moments in our lives when we are in a positive state of mind, and we feel right about everything. We like people around us and praise them, and we think positively about everything. And you are generally ready to take more risky decisions.

But then there are days when you are in a negative state of mind, and you tend to get irritated by people or things. So this is a classic example of the affect heuristic. Affect heuristics work at a subconscious level and shortens the decision-making window's time with the help of changes in mood as a response to a stimulus.

Conclusion

While these mental shortcuts allow people to make quick decisions, which are usually accurate, they can also lead to poor decision-making. 

A classic example of this is when you see an advertisement on television, and it shows the consumption of smoking or unhealthy foods, it might seem positive and appealing to you. These kinds of scenes can sometimes influence consumers, which can lead to poor health decisions and risky behavior that can have serious long-term consequences.

These heuristics may sometimes end up becoming a bias. It should be noted that the Heuristic, which has worked in past situations, may not work in other conditions. It affects us through stereotyping.

It can also lead you always to make decisions of the same standard type. People who use heuristics a lot or more often develop it as their permanent style of attitude or behavior, and this is where the biases emerge. So it is essential to understand these heuristics and knowledge about their potential to help an individual make more accurate decisions.

comment on this article
share this article
Photo of Rashmeet Kaur

An Article By -

Rashmeet Kaur

15 Posts

95.9k Views

1 Post Likes

2

Rashmeet Kaur is a certified investment advisor. She is aiming to be a financial analyst, and is the one who encourages reading and loves to explore economics and stocks. She loves to discover her own style while writing, and wants to live a creative and adventurous life. 

Topics under this Article

Share your thoughts

We showed you ours, now you show us yours (opinions 😉)

no comments on this article yet

Why not start a conversation?

Looks like nobody has said anything yet. Would you take this as an opportunity to start a discussion or a chat fight may be.

Under Investor's Psychology

"A few" articles ain't enough! Explore more under this category.

close
Share this post
share on facebook

Facebook

share on twitter

Twitter

share on whatsapp

Whatsapp

share on linkedin

Linkedin

Or copy the link to this post -

https://insider.finology.in/behavioral-finance/how-heuristics-influence-decision-making

copy url to this post
Copied