A Fourth Dose Of Bias
Human brains are incredible – the average generates 50, 000 thoughts per day. Our thoughts and actions are a combination of rational analysed outcomes, and more automated responses – biases we’ve developed over centuries of evolution.
Whilst these biases serve well for efficient responses – and account for a lot for your gut feel – they can often cause us to miss valuable information. For complex tasks such as corporate strategy, or investing – whilst it is critical to be aware of these biases, they don’t always guide you to the best outcome. It is rather better to identify them and minimise their influence. This is the fourth chapter in a focus on the more common biases seen in investing (please click the links to see part 1, part 2 and part 3). Today we introduce Confident Camilla, Disposition Daniel and Available Andrey.
Bio: Camilla knows it all – she’s sure of it. Rocket science? Olympic gymnastics? Tchaikovsky’s? She’s got all the facts, been there, done that. She knows more than you and is practically besties with our friend Chuck Norris.
Weapons: Confidence is great – you need to have conviction to make your calls. However – too much and you close your mind. Placing unquestioned assumptions into your analysis can make Camilla a costly bias. We all have a little of her in us – in fact Professor Michael Mauboussin made a quick online trivia test where you can test your over-confidence, Andrew Macken wrote about it last year.
Defence: One great defence for over-confidence is to step back and verify your facts. Check every assumption – even the ones that seem obvious. Group discussions and debates with experts provide a forum to challenge your thoughts and help identify things you may have assumed without proof.
Bio: Daniel’s not a momentum guy, he’ll make a call and very much likes to be proven right on it. When something goes against him, he’ll stubbornly hold on – not wanting to cement the loss. When he’s right, he’s quick to take money back off the table.
Weapons: Daniel will tell you not to realise a loss, to wear it out – even when things may have changed. He’s patient – but may miss a structural change. Conversely, he’s keen to pocket a quick gain and may rush before checking if there’s further good news in store.
Defence: Whether holding too long or selling too early – Daniel needs to be combatted with the same prescription. An unemotive rational evaluation of the fundamental valuation is necessary whenever new information comes about. It is from this clean slate that a new buy or sell decision needs to be made.
Bio: Andrey’s always there when you need him. You hung out last weekend when he helped you score a steal at the Myer sale – really made you think about the discounting you’re seeing across the board. He saw when you lost money on your latest call. He’s always your most recent data-point.
Weapons: You know Andrey on a personal level – he’s a part of your experience and shapes the lens through which you see the world. This helps him connect more with you than some less relatable data. We tend to attribute more relevance to recent memories and our own experience than less relatable information.
Defence: Whilst experience helps us refine our mistakes, we need to rely on all available data – not just our latest trip to the mall. Relying too heavily on Andrey can let you fall into the trap of small sample bias when collecting data, or not re-evaluating a position simply because you were wrong previously.
“The best investors know intellectually what the right thing to do is. But while this knowledge gives them comfort, they have to tamp down their feelings in order to follow it… most great investments begin in discomfort” – Howard Marks
Roger's step-by-step guide to valuing the best stocks and buying them for less than they're worth, Value.able, is available exclusively at rogermontgomery.com. Skaffold is an online stock-picking application that rates ASX-listed stocks from A1 to C5. Watch a demo of Skaffold at www.skaffold.com.