Investing Biases and overcoming them

We all can suffer some bias when investing, understanding this can help us control ourselves.

Anyway, a few examples off the top of my head;

Original bias, we can put more merit/weight to the first information we process

Result bias, after a positive or negative result we show bias (negative or positive) towards something or a decision making process that may or may not be valid. i.e. If you bought STW in 2007 "ETFs are the worst", or you bought STW in 2009 "Index ETFs are the best!"

Outcome/desire bias, you want something to occur so you find ways to justify it

Recent bias, the last thing you heard/read is a fantastic new idea that blew your mind

Statement bias, digging in to a point of view once you have expressed it, especially if defended in an argument.

Some of the things I have read suggest the only way to overcome bias is to pick an investing strategy and sticking to it no matter what. There are numerous reasons why this is a poor idea IMO, such as your original thesis was incorrect or macro factors have changed the viability of your strategy. At the same time we need to have conviction to stick to our good ideas.

How many people think about these kinds of things and have strategies to manage them?

I'm speaking in regards to share investing and analysis so I am posting here rather than the psychology section.

 

I thought shares were a gamble. Lost 7k on shares back at uni. Made money on Telstra sold at $9. (Peak!)
So that's how I thought the stock market should be treated. I.e. Trading for capital gains based on the share price. So I used property as my main investment vehicle for a long time. That you can "safely" leverage for property, thanks to listening to some seminars and reading books like rich dad, poor dad. Anyway, I was thinking of making commercial my next move because of the yields, but there are some less than perfect things about commercial which I am not comfortable with. E.g. The prospect of long vacancies.

But after reading shares vs. property threads, listening to other Forumites, listening to Thornhill I have come to the conclusion shares are indeed safe. (If you know what you are doing, of course).
Now my thought is investors should look at buying stocks for the long term and collect dividends. My thoughts towards shares have done a 360* about face.

I find to learn, an open mind is required. I was willing to learn, and investigate and see based on facts that stocks are safe. Of course, something like 1 out of every 6 years may give a negative return. But the other 5 out of 6 years being gains means the returns are high overall and shares are a long term performer.

I have a science degree and the great thing about science is that if something isn't the best explanation for something and a better explaination/theory comes along, you discard the old theory and adopt the new one. And you continue to do that over time, refining ideas.

Whereas I know people who are into religion. Most religions don't move with the times. So if someone says the world was not created but that we evolved from other animals, that's where science and religion clash. Of course I want science to win out. I think with science in mind. Not religion.

 

Ok, now we are talking. This is valuable stuff.

I'll come back to this later (maybe a week or two), but if you haven't seen it google the Munger human misjudgement talk. Have you read Roberto Cialdini at all ? It's all linked. I'm working through a behavioral investing book by James Montier at the moment. Ben Carlson is always good for this stuff too, as it applies to current / past financial events. He has a couple of relevant updates at the moment.

Much more important than product choice imho!

 

Charlie Munger has one he calls lollapalooza which is a combination of numerous cognitive biases. Poor Charlie's Almanac is a great book to partake in Mungerisms. Not a cheap tome but worthy of a spot in every library. He is wise and funny.

 

It's a weighty tome isn't it! A coffee table book for investment nerds.

 

The topic of human biases and heuristics is well research in the field of risk analysis and decision making under uncertainty. Daniel Kahneman and Amos Tversky conducted decades of research in the field. Kahneman won the Nobel Memorial Prize in Economic Sciences for his work in 2002. I wholeheartedly recommend his book "Thinking, Fast and Slow" to those interested in how humans think and make decisions.
We all suffer from this 'illness'. Sadly, at least in my case, knowing about it makes me none the wiser:-(

 

One of my favorites to use is the anchoring effect. Basically if you see/hear a number it becomes an 'anchor'. You can use it esspecially well in negotiations very subtly. The number doesnt even have to be related.

For example lets say you are targeting $100,000 for a salary.
If you start a discussion about a nice car, and mention they sell for between $100,000 and $120,000 this number becomes an 'anchor', albiet completely irrelevant to the salary discussion.

Without even knowing it, you have your bait anchored to a number, and they dont even realise it.

Blacky

 

I have got to try that.

 

This may well be the most important post I've read all year.

Thank you.

 

Read as much material as you need to be convinced of what's required.

In the end it will come down to a few simple rules. Unfortunately then it's a case of practice makes perfect, that thing called experience.

Am I perfect, no far from it. I've made just about every mistake possible. To avoid the misery I've experienced make an effort to identify your behavioural weaknesses then develop processes to minimise the risk of these undermining success. But don't underestimate how hard it is. For some of us it's a never ending battle.

A lot of these concepts are behind the success of index funds, asset allocation, diversification, DCA and rebalancing. The sooner you can accept that beating the market is extremely difficult and put in place automated investing processes the more likely you will be successful.

It's not what I do (yet) but experience has allowed me to fumble my way to reasonable Investing success despite my shortcomings. But my goal is to continue to get progressively better.

 

Linky

Just to show Im not making this up

 

I feel like Thinking, Fast and Slow, is a great piece of literature, but v boring, I lost interest in all the repetitions of his point.

My favourite book that covers the heuristics and biases of the mind is You Are Not So Smart, its much more succinct and enjoyable to read for me.

 

I haven't put near enough effort into this area. Charlie's talk is only an hour long for 24 points, each point would take me an additional hour just to process and understand to a basic level. Getting myself a more general understanding I feel will accelerate my ability to absorb the material.

To get more serious about this (and investing in general) I need to get myself a book to take notes and ideas which I can review etc. I am amazed at the ability of many here to pull relevant information and sources as discussed, seems in one ear and out the other with me at times, which is unfortunately a sign of a lack of deep understanding and application IMO

 

A good book is "Your Money and Your Brain" by Jason Zweig

 

Just curious.... no one shoot me, but are some of these books a bit like those self help psych books, the information is helpful at the time, a real light globe moment..... but unless you continually enforce what you learn on a daily basis it does not take long and you are back to square one????

 

Yep!

That's the same with everything. Bold emphasis mine.

 

Yes

Was specifically thinking about these Land Mark seminars, I have a couple of friends that have been to these.

All good on completion...... they seem to be on a high, they even write letters to their parents who have in one case passed away, to help their inner child ..... but after 3 months seems back to reality.

Not against this at all, whatever rocks your boat.

 

@Hodor,

I'd strongly suggest you read these first:
The World According to Intelligent and Emotional Chickens
http://freefromharm.org/chicken-behavior-an-overview-of-recent-science/

 

LOVE this thread, very valuable topic to raise thank you Austing!

To cut to the chase the problem is people simply don't know what they don't know and further more they dabble in or experience one thing and think that is all they need to know.

I see a HUGE amount of this bias in my work as a financial planner and here are some examples of the things I have heard over the years and these are mostly investment related, I have also heard a lot of insurance, super, cash flow, estate planning, tax planning examples. I'm sure a lot of these comments will sound familiar to many members.....

"Property is much safer than shares"

"Property always rises in value but shares are more like gambling"

"We only want to invest in property because we have made money on one in the past"

"Shares are too risky"

"We don't know anything about shares so we think it's best to leave them alone"

"Uncle Billy told me he lost all his money in shares so I no way am I investing there"

"What if my share portfolio goes down to zero value?" (in reference to a diversified portfolio of 100's of blue chips)

"Investment property is the only asset class worth investing in"

"I don't trust Super so I don't want to start one up" (Self employed worked in mid 40's with no Super and very little assets).

"We don't need any help managing our budget, just show us the best investments" (client had multiple messy debts, far too much non deductible, and obviously no control of basic cash flow)

"Insurance companies are always looking for ways to get out of paying"

"I don't believe in insurance" (HUH? You like putting your family and income at risk?)

"I want to get into negative gearing" (client had good cash reserve but was on a low income)

"Managed funds are not as good as direct shares" (Holy Moses don't get me started - this is something I hear a lot and is an absolutely crazy way to think unless your goal is to put yourself in a position where you have to work on managing your assets 24/7)

"Managed funds are too expensive" (Said by client who was currently managing own portfolio underperforming index by serious amount, nearly any decent MF would have done MUCH better net of the fees and saved the client many hours a week of work)

"I would rather save the fees" (and cost yourself a fortune for being unable to recognise when you need help and expertise)


These are the ones that spring to mind immediately but of course there are hundreds more examples and I have probably forgotten more than I remember.

 

One attendance to a Thornhill day and most of these individuals would benefit!

Many people are fearful of stocks but if they understood it, they wouldn't be. They just don't have the understanding... and many of these people simply don't want to learn.
The student just isn't ready... and they may never be ready. Or you can lead a horse to water but you can't make it drink... It's to their loss...