Narrative fallacy: Why do humans tend to create a narrative for any event, even when the narrative has no basis?
The narrative fallacy addresses our limited ability to look at sequences of facts without weaving an explanation into them or, equivalently, forcing a logical link, an arrow of relationship upon them. Explanations bind facts together. They make them all the more easily remembered; they help them make more sense. This propensity can go wrong when it increases our impression of understanding.
— Nassim Nicholas Taleb, The Black Swan
We are all to love stories.
We all grew up listening to stories of heroes who conquered the mountains and ruled the world. Habitually, stories have been emotional content that appeals to our subconscious or reflexive reasoning. Because stories have that emotional component, they’re easy to remember. When teachers are lecturing to students, they often use stories to keep the lesson interesting. They do this so that students can more easily retain and recall information in the form of a story.
The narrative fallacy uses our innate love of stories. Narrative fallacy illustrates what happens when a person puts a series of circumstances, happenings, or life events into a logical order to process it more easily. It’s an important function that helps us deal with everyday life.
As Nassim Taleb points out in his book, Fooled by randomness, there is a profound biological basis to the problem: we are inundated with so much sensory information that our brains have no other choice; we must put things in order so we can process the world around us. It’s fundamental in how we understand the world. When the coffee cup falls, we need to know why it falls. (We knocked it over.) If someone gets the job instead of us, we need to understand why they were deemed better. (They had more experience, they were more likable.) Without a deep search for reasons, we would go around with blinders, one thing simply happening after another. The world does not make sense without cause-and-effect.
The dangers of a good narrative
Although storytelling helped our hunter-gatherer ancestors survive, it can still lead to irrationality, bias, and poor decision-making today.
Business people are heavily prone to peddling narratives. Over the past years, we have been hooked on rags-to-riches stories of gritty entrepreneurs who put it all on the line to launch world-changing businesses. A CEO is known for his methodical, rigid style. If his company does well, they compliment him for sticking to his guns with clearly the right strategy.
Our brains assume that their causal narrative is likely to be true. If we wrongly believe that they predicted future events correctly, we might be tempted to act on their assumptions going forward. Stories get simplified and compacted.
When the story of successful businesses entrepreneurs is retold, take, for instance, the story of the Paypal mafia. It is a group of former PayPal employees and founders who have started other technology companies such as Tesla, Inc., LinkedIn, Palantir Technologies, SpaceX, Affirm, Slide, Kiva, YouTube, Yelp, and Yammer.
Narratives get attention. They get funds for science studies, and they attract charitable donations. They fuel political campaigns. And they draw attention to financial news. No one would watch business news with the headline, “Stocks went down today, and we have no clue why.” As Taleb puts it, the headlines would be more accurate than most business news.
The predicament with stories is that they may have negatively dominated how we think. Interestingly, in the financial markets, we often abandon evidence favoring a good story. Narrative fallacy is why people sometimes avoid value investing, which pushes investors to look at the companies that may not have the best stories. They often have horror stories. The most admired companies have the most remarkable stories, but they also tend to be overpriced.
People buy and sell various company stocks for many different reasons, most of which have little to do with the daily news narrative. Yet, Stockbrokers have taken advantage of the narrative fallacy for years, convincing clients to invest in a company by telling them a great story about the company.
