Bounded Rationality
Why do we rely on shortcuts when making decisions, even when more complete information is available?
There are moments when a decision could be analysed in great detail, yet it is made quickly, based on a smaller set of considerations. Not because the rest of the information is unimportant, but because it is difficult to process everything at once. Time is limited, attention is selective, and complexity can quickly become overwhelming.
This is where bounded rationality begins to provide a useful lens. It describes the idea that while people aim to make rational decisions, their ability to do so is constrained by limits on information, time, and cognitive capacity. Rather than seeking the optimal solution in every case, individuals often settle for one that is good enough within those constraints.
The concept was developed by Herbert A. Simon, who challenged the traditional assumption that individuals always act with perfect rationality. He argued that in real-world situations, decision-making is shaped by practical limitations. As a result, people use simplifying strategies, often referred to as heuristics, to navigate complex environments.
One of the central insights of bounded rationality is that these shortcuts are not necessarily flaws. They are functional responses to complexity. Without them, decision-making would become slow and impractical. The trade-off is that while heuristics make decisions possible, they can also introduce systematic biases.
In markets, this can be seen in the way information is filtered and prioritised. Investors do not analyse every possible variable. Instead, they focus on a subset of signals — recent price movements, familiar narratives, or widely discussed ideas. Decisions are shaped by what can be processed, rather than by the full set of available information.
What makes this important is that it shifts the perspective on behaviour. Rather than viewing biases as isolated errors, they can be understood as natural outcomes of operating within constraints. The same mechanisms that allow decisions to be made efficiently can also lead to patterns that repeat across individuals and markets.
You may recognise this in your own decisions when you rely on familiar signals, simplify complex choices, or prioritise certain types of information over others. There can also be a tendency to feel confident in a decision, even when it is based on a limited subset of the available data.
Bounded rationality does not mean decisions are irrational.
It just means they are made within limits.