Ideas

Practical Tips for Ignoring Investment "Noise"

We live in a noisy world that is getting noisier every day. Faced with an onslaught of information that we are wired to misinterpret, we must develop simple strategies for making sense of it all. A few suggestions include:

Base Camp – Our imperfect memories and insensitivity to base rates means that we are likely to confuse ease of recall with probability. Wherever possible, seek out historical probabilities and rely on them as best guesses for your own course of action. If it takes most people two years to write a book, you’re unlikely to knock one out in three months. If most people should diversify because single stocks are risky – so should you.

Look for the Overlooked - Nassim Nicholas Taleb hilariously relates a story that speaks to how we think about innovation and how our best efforts to be creative can be thwarted by our tendency to overcomplicate things. As Taleb points out, the wheel was created over 6000 years ago, but the wheeled suitcase was not invented until 1970. In fact, humankind even achieved manned space flight (May 5, 1961) before the invention of the wheeled suitcase! Are there simple, elegant solutions that you are overlooking by trying too hard?

Keep it Simple - Just as more information about Linda the bank teller (look up this experiment if you're not familiar!) makes us less capable of judging what really mattered, so much of what passes as investment advice is marketing or clickbait with a thin educational veneer. A part of any sensible approach to security selection is determining what matters most and a focus on those variables to the exclusion of the cacophony all around. True investment signal consistently passes three tests – 1. It is common sensical (i.e., no Bangladeshi butter production) 2. It is research based 3. It endures as a result of a behavioural component.

Check Yourself – One type of information is deserving of extra scrutiny and an added dose of skepticism; information that you are excited to hear. Your excitement about believing something and your incredulity should be inversely proportional to one another.

Practical Tips for Overcoming Overconfidence Bias

If you’re now convinced of the need for greater humility in your investment approach, a natural next question is, “Where do I start?” The journey toward admitting ignorance and culpability is winding and difficult but has both financial and relational rewards. Here are a few places to start:

Man of steel – You’ve likely heard of a “straw man” argument in which a weakened caricature of an opposing opinion is presented, only to be dismantled. A less discussed but more effective critical thinking technique is to create a “steel man”, which represents the very best thinking and most rigorous empirical proof of an opinion with which you disagree. Rather than using the straw man as a rhetorical punching bag to feed your ego, build a steel man that will sharpen your thinking, cause to you to look in dark corners and consider new vantages.

Love the questions – In Letters to a Young Poet, Rainer Maria Rilke writes to his protégé: “I want to beg you, as much as I can, dear sir, to be patient toward all that is unsolved in your heart and to try to love the questions themselves like locked rooms and like books that are written in a very foreign tongue. Do not now seek the answers, which cannot be given you because you would not be able to live them. And the point is, to live everything. Live the questions now. Perhaps you will then gradually, without noticing it, live along some distant day into the answer.” Western culture is in love with certainty and bravado but the uncertainty of markets necessitates that we pursue a dynamic approach that is rooted in a fascination with the process rather than looking for silver bullets. The paradoxical truth is that only by learning to love the questions will we ever find the answers.

Take Your Time – For years scientists have puzzled at the evolutionary reason for depression. Species tend not to adapt in ways that are self-harming and yet depression on its face does very little good and a whole lot of harm to the organisms it touches. But more recent research shows that deep sadness may have a strong evolutionary purpose that is rooted in the depressive tendency to ruminate on problems. By playing and replaying a negative event over and over in our minds, we often arrive at solutions that can be called upon at a future date. What hurts in the moment may be profoundly beneficial down the road. As Warren Buffett has pointed out, there are no called strikes in investing; all the time pressure we may feel is arbitrary and self-imposed. We would do well to follow the admonition of John Dewey in How We Think, - “To be genuinely thoughtful, we must be willing to sustain and protract that state of doubt which is the stimulus to thorough enquiry, so as not to accept an idea or make a positive assertion of a belief, until justifying reasons have been found.”

Take the outside view – When making a decision we tend to rely on what social scientists call the “inside view.” The inside view is our perception of a decision as informed by our own biases, anecdotal experience and a convenience sample of whatever data pops to mind first. Conversely, taking the “outside view” means a more dispassionate appraisal that depends more on base rates, probability and facts than convenience and personal experience. In Think Twice, Michael Mauboussin sets forth four steps to taking an outside view of a problem. They are:

1.     Select a reference class – compare your problem to other problems like it

2.     Assess the distribution of outcomes – examine rates of success and failure

3.     Estimate probabilities – based on the external evidence, estimate timelines, failure rates and obstacles to success

4.     Fine tune your prediction – let bumps in the road and changing circumstances alter your estimate accordingly

By relying on external data, you are likely to arrive at a much more realistic picture than by leaning on your personal experience. If it takes most people two years to complete a task, you are unlikely to finish yours in six months. The outside view is an effective way of combatting ego risk by reminding you that you’re not that great.

Those who can, teach – A quick question for you, gentle reader, “Do you know how a toilet works?” On a scale from 1 to 10, how familiar would you say you are with the workings of a toilet? Go ahead and answer. Now, explain to me in detail the mechanics of a toilet, I’ll wait. Done? Ok, now let me ask again – on a scale of 1 to 10, how well do you understand the workings of a toilet? Research by Steven Sloman of Brown and Philip Fernbach at the University of Colorado shows that having to teach a concept has a humbling effect that brings our beliefs more in line with our actual understanding. The pair have used this technique to moderate beliefs about everything from single payer healthcare to, well, toilets and have found that, “As a rule, strong feelings about issues do not emerge from deep understanding.” The next time you feel as though you must buy or sell a security, take a moment to explain, in detail, the factual reasons why this is so. You’re likely to find that your enthusiasm has gotten the best of your brain and nothing brings them back into sync like having to teach.

5 Tips for Overcoming Overconfidence Bias

One of the strange paradoxes of human psychology is that our tendency to be overconfident has both helpful and harmful aspects. After all, starting a restaurant or a small business both have low odds of success, but we are awfully glad that overconfident dreamers do it anyway! But while overconfidence may help us get out of the bed in the morning or encourage us to embark on an entrepreneurial journey, its impact on investment decisions is unfailingly negative. Today on the podcast, tune in to hear five concrete ways to beat overconfidence en route to having a more fulfilling life.

Listen HERE or on Apple Podcasts.

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The Dangers of Overconfidence (Part One) - Special People are Quitters

Dmitri Martin, one of my favorite comedians, is known for his humorous sketches, delivered deadpan, that speak to harsh truths with which we are all well acquainted. One such sketch is the one where he compares most peoples’ concept of the path to success with the actuality of the path to success.

Most of us know intellectually that hard work and failure often precede success. We probably even have a couple of go to anecdotes (that do little to make us feel better about our own shortcomings, incidentally) – Michael Jordan was cut from his high school basketball team, Thomas Edison failed thousands of times before inventing a commercially viable light bulb filament. But, however much we may wish it were different, success is typically preceded by a good deal of imperfection and those who go on to do great things are the ones who learn to fight through.

So, what does a feeling of personal specialness have to do with stick-to-it-ive-ness? A great deal as it turns out. Carol Dweck and her team have pioneered the research in this field in the trenches of the New York City school system. Dweck’s team took a random sample of children out of their fifth grade classes, and in the first round of the experiment, provided them with puzzles simple enough that most children could excel. To the first group of children, she complimented their intelligence, “You did well, you must be very smart.” To the second group, she complimented their effort, “You did well, you must have worked very hard.”

For the second round of the test, the children were given an option. They could choose a harder test or a test equivalently hard to the first. Of those praised for hard work, 90% opted for the harder option, whereas a majority of those praised for intelligence opted to stay with the easier test.

It seems that people who believe that they are naturally gifted tend to quit earlier and choose simpler tasks than those who have been socialized to work hard. Feeling special produces a euphoric high that people are understandably hesitant to part with. Thus, when special people are confronted with an especially difficult task, they often back down, seeing it as a threat to their “crown of giftedness.” After all, why risk the possibility of failure when you could bask in the safety of “specialness?”

Many a doting parent has sought to buoy the self-esteem of their little darling by telling their son or daughter that they are smart. After all, it stands to reason that intelligent people are more successful and in the case of girls, it circumvents the sexist habit of focusing solely on attractiveness. But thirty years of research tells us that focusing on effort rather than specialness is the best way to encourage young Einsteins.

Dr. Dweck relates the story of “Jonathan” (a composite character) in her seminal article, The Secret To Raising Smart Kids.

“A brilliant student, Jonathan sailed through grade school. He completed his assignments easily and routinely earned As. Jonathan puzzled over why some of his classmates struggled, and his parents told him he had a special gift. In the seventh grade, however, Jonathan suddenly lost interest in school, refusing to do homework or study for tests. As a consequence, his grades plummeted. His parents tried to boost their son’s confidence by assuring him that he was very smart. But their attempts failed to motivate Jonathan. Schoolwork, their son maintained, was boring and pointless.”

What many a well-meaning parent has done when emphasizing innate gifts is create the perception that achievement is based on leveraging specialness rather than hard work. When children view themselves as special or gifted, they become accustomed and entitled to having work come easily to them. When it does not, they write it off as “stupid” or “boring.” Worse still, they believe themselves to be ineffectual in doing differently, since after all, their past ability to excel has all been predicated on natural gifts they did nothing to earn.

This mindset is doubly damning. When a child is successful, they are unable to truly take credit for their success, since it is a natural consequence of their unearned gift. When they are unsuccessful, they have no culpability and could not have done any better, since success is contingent upon a talent with which they were not blessed. This “either ‘ya got it or ‘ya don’t” attitude leads to something that psychologists call “learned helplessness.”

LEARNED HELPLESSNESS

The original research on learned helplessness was conducted by one of the fathers of positive psychology, Martin Seligman. Dr. Seligman’s experiment tested two groups of dogs. The first set of dogs were harnessed in and given a mild electrical shock which could end by pressing a lever inside of their cage. Soon enough, the dogs stumbled onto the correct response and learned to act in every instance of discomfort. The second set of dogs were similarly harnessed and shocked, but were initially unable to bring about the cessation of shock by pressing the lever. After repeated pairings with this helpless situation, they were then placed in new cages where their action could bring about the end of the shock by pressing the lever. Sadly, by this time, the dogs had conditioned themselves to helplessness and directed their energy toward enduring the pain rather than improving their plight.

It is easy to draw parallels between the helplessness of the dogs and a student who has bought into the notion that success is predicated entirely on innate specialness. After all, his success and failure is seen as being entirely out of his hands – so why try? Given the unintended consequences of praising children as special, Dweck and other experts on giftedness encourage taking a different tact. Rather than praising giftedness, they recommend praising hard work and encouraging a growth mentality. In so doing, children learn that they will be praised for process rather than outcomes. This approach empowers young minds and teaches them success is in fact a byproduct of effort and that whatever their natural gifts may (or may not) be, they can bring about improved outcomes with sweat equity.

The parallels between the examples given above and investors may not be immediately obvious, so let me take a run at describing why I think that overconfidence is one of the most harmful behavioral traits an investor can exhibit. Equity investing is, by its nature, an act that requires humility, patience and a willingness to be self-critical, none of which are hallmarks of overconfident people. Investors with an "I'm special" mentality, enter the capital markets and expect immediate success, which Mr. Market may be stingy to produce. When the overconfident investor doesn't achieve his desired result, he may quit altogether (dangerous) or double down in an effort to attain the return that he is "due" (doubly dangerous). Just as a child labelled gifted may quit too easily when school becomes tough, an overconfident investor may pout if they do not live up to their own internal hype as a Junior Warren Buffett. With both the child and the investor, the fix is the same - focus on process. You aren't special, but your discipline can be. The market may not be in your control, but your reaction to it is. In the long-term, achieving satisfactory returns in the stock market is less about being gifted and more about being process-driven. The bad news? You're not that great. The good news? Realizing how average you are is the first step toward doing something extraordinary. 

Want more great content on the intersection of mind and markets? Check out The Laws of Wealth by Nocturne Capital founder Dr. Daniel Crosby - HERE