Ideas

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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Confirmation Bias (Part One) - A Lot of What You Believe is Wrong

THE PERSISTENCE OF BELIEF

I have often found it to be the case that the humanities have long observed what science is only later able to explain in greater detail – personal beliefs are hard to extinguish, even in the face of evidence that they are untrue. Fifth Century Greek Historian Thucydides wrote, “it is a habit of mankind…to use sovereign reason to thrust aside what they do not fancy.” Sir Francis Bacon posited that, “The human understanding when it has once adopted an opinion…draws all things else to support and agree with it. And though there be a greater number and weight of instances to be found on the other side, yet these it either neglects or despises, or else by some distraction sets aside or rejects.”

But perhaps no one has written on the topic as lucidly as Leo Tolstoy who wrote, “I know that most men – not only those considered clever, but even those who are very clever, and capable of understanding most difficult scientific, mathematical or philosophical problems – can very seldom discern even the simplest and most obvious truth if it be such as to oblige them to admit the falsity of conclusions they have formed, perhaps with much difficulty – conclusions of which they are proud, which they have taught to others, and on which they have built their lives.” Simply put, once we have formed an opinion, especially one central to our worldview, we cling tenaciously to that opinion even when the facts may speak to its wrongheadedness.

THE SCIENCE OF BELIEF

The 2004 Presidential campaign pitted the incumbent President George W. Bush against the Democratic challenger John Kerry. It also provided an opportunity for brain researchers to study the science of what makes belief so “sticky.” Researchers began by gathering candidates who professed have a well-defined presence for one candidate over the other. Participants were given seemingly contradictory statements either from President Bush, Senator Kerry, or a third politically neutral public figure. They were also given further information that made the seeming contradiction appear more plausible. They were then asked to determine whether or not the individuals in questions had in fact made statements that were inconsistent.

During the evaluation and thought process, research participants were monitored inside a magnetic resonance imaging (MRI) machine that allowed the scientists to observe their brain activity. As subjects evaluated seeminglycontradictory statements made by their less-preferred candidate, the emotional centers of their brain remained inactive. This allowed them to make cold, rational judgments about these statements. However, as the subjects evaluated the statements of their preferred candidate, the emotional centers of their brain became highly aroused. When the results were tallied, there were clear differences in the evaluations.

Subjects were very likely to endorse their less preferred candidate as having said something contradictory and were highly unlikely to say the candidate of their choice had made such a rhetorical error. Simply put, when their guy said something incorrect, their emotions drown it out, but when “the other guy” said something implausible, they rationally pointed out the fallacious thinking. The inference we can draw from this experiment is that the emotional tumult created when facts collided with logic fell down on the side of emotion. Belief is an emotional construct, we feel it deeply, and are loathe to let silly facts tell us that we believe is not so. This emotional reaction created a situation whereby the status quo was maintained and previously held beliefs were confirmed, even when logic would have suggested otherwise. In simple terms, we rationally evaluate things that do not intersect with our worldview and emotionally evaluate those that do. 

THE PATH FORWARD

Hopefully by now you’re convinced by now that questioning some of your deeply held assumptions, while difficult, is a worthwhile undertaking. Rene Descartes, considered by many to be the father of Modern Philosophy did something similar when he sought out to question everything he thought he know, famously arriving at the one thing he could know for certain, “Cogito ergo sum (I think therefore I am).”

Granted, Descartes exercise is a little impractical, but it does set a positive precedent in some respects. So much of what we assume we “know” has been passed down to us somewhat uncritically. We’ve accepted the lessons we’ve learned from our parents, teachers and the other salient personal and cultural influences that have been instrumental in shaping our worldview. Would it really be so bad to give some of that a second look – leaving what we no longer found to be true and newly embracing timeless truths?

The Challenge: Ask yourself today - what "untrue-isms" might I be holding on to by evaluating them emotionally rather than logically?

To learn much more about the intersection of mind and markets please check out The Laws of Wealth by Dr. Daniel Crosby - HERE

 

The Dangers of Overconfidence (Part Two) - Special People are Cheaters

THE MYTH OF SELF-ESTEEM

Beginning with the 1969 publication of The Psychology of Self-Esteem, wherein Nathaniel Branden posited that self-esteem was the single most important facet” of personal well being, the self-esteem movement has been one of far-reaching influence. In the 70’s and 80’s anything seen as detrimental to self-esteem was done away with. Gold stars proliferated while red pens gathered dust. First place trophies gave way to awards for participation. In this new milieu, everyone was a winner; everyone was special. 

As this well-intentioned movement garnered support, scholarly research followed. In the thirty-year run up to the 21st century, over 15,000 articles were written on the impact of self-esteem on, well, pretty much everything imaginable. However, the results of these myriad studies were often confusing or inconclusive. In an attempt to make sense of the general trajectory of the literature on self-esteem, the Association for Psychological Science asked Dr. Roy Baumeister, an admitted proponent of the theory, to meta-analyze the extant data on the subject. What followed was what Dr. Baumeister would go on to refer to as “the biggest disappointment of my career.” 

Of the 15,000 studies taken into consideration, a paltry .013 percent of them (n = 200) met the more rigorous standards for inclusion into the meta-analysis. To begin with, it became apparent that many of the theories about self-esteem that had impacted policy were simply junk science. What’s more, the studies that did pass muster didn’t have much good to say about the construct’s predictive power. Self-esteem did not predict academic or career achievement, nor did it predict drug usage or violent aggression. The biggest finding to emerge from the self-esteem movement was that praise did not predict self-esteem, accomplishment did. Telling someone that they are special is insufficient if they have not worked to earn it. We have an accurate internal sense of when we have earned praise and when we have not. If we feel as though we are being patted on the back undeservingly, it does not move the self-esteem needle one inch.

THE ETHICS OF GIFTEDNESS

One of the thoughts behind the self-esteem movement was, that if you imbued people with a positive vision of themselves, they would be less likely to engage in anti-social behavior. Once again, the reality of specialness deviates quickly from the aspirational theory that underlies it. In fact, research shows that those who think of themselves as gifted, will often do anything to protect that label – even if it is unethical.

One of the most direct studies of this phenomenon involves students who were asked to fill out a “do it yourself” report card that would ostensibly be mailed to students at another school. The children involved were told that those on the receiving end of these report cards would be strangers – they would never meet them nor would they exchange names. By setting up the experiment thusly, the researchers were able to promote a scenario that would allow the children to lie with impunity, if they so chose.

Before filling out the DIY report cards, the kids were either praised for their effort or for being naturally intelligent. While very few of those praised for effort dissimulated on the grades self-assessment, 40% of those lauded for their specialness lied in their self-reports of academic achievement. Again, the shroud of specialness created a pleasant illusion that the students wanted to perpetuate at all costs. Whereas being complimented for being hard working has a wholesomeness that is it’s own reward, specialness is something that is won or lost in the outcomes. The impact of dishonesty is bad enough, but what if this dynamic played out on a grander stage and with infinitely higher stakes?

“A LITTLE JEWISH GUY FROM BROOKLYN”

By now we are all familiar with the story of Bernie Madoff, the financier who brokered the largest Ponzi Scheme in US history. In the case of Madoff, our familiarity with the story may actually be a disservice to an appropriate understanding of his motives. After all, in the minds of “have nots”, wealth is its own reward. Who wouldn’t want a private jet? Who wouldn’t want a $200,000 watch? We assume a very simplistic motive on Madoff’s part – greed. But the reality may not be that simple.

While the timeline for Madoff’s transition from legitimate businessman to crook is unclear, it appears as though he began his career on the up and up. In fact, Madoff’s firm legitimately pioneered the use of computer information to disseminate stock quotes. This technology was so groundbreaking, that after some initial testing it become what we now know as NASDAQ. Despite all of his success, Madoff felt unnoticed and unextraordinary saying, “I was upset at the whole idea of not being in the (Wall Street insiders) club. I was this little Jewish guy from Brooklyn.” For someone who had done so much and went on to cause such trouble, Madoff sounds weak and vulnerable in his account of his early career.

Much like a professional athlete who turns to “juicing” to rise to the top, Madoff began to apply his financial acumen in a more sinister manner, officially defrauding his investors (which included Holocaust survivor charities) of over $18 billion. But as he has said in interviews, it really was never about the money. Said Madoff, “We made a very nice living. I didn’t need the investment-advisory business. I took it on and got myself involved in it, but if you think I woke up one morning and said, ‘Well, listen, I need to be able to buy a boat and a plane, and this is what I’m going to do,’ that’s wrong.” Madoff’s subtext? It was never about the money, it was about respect.

Before long, Madoff’s too good to be true returns did result in the recognition he craved. “The chairman of Banco Santander came down to see me, the chairman of Credit Suisse came down, the chairman of UBS came down; I had all of these major banks” he says, “It is a head trip. (Those people) sitting there, telling you, ‘You can do this.’ It feeds your ego. All of a sudden, these banks which wouldn’t give you the time of day, they’re willing to give you a billion dollars.” Now Madoff was special, but as we have seen, with recognition comes the tenuous task of maintaining the label. Madoff was now a prisoner of his own need to be recognized. He said of living this lie, “It was a nightmare for me. I wish they caught me six years ago. Eight years ago.” Even in the face of this torment, he was unable to free himself from his need to be thought of highly by his peers, the Wall Street insiders who had never really accepted the Jewish kid from Brooklyn as one of their own. 

I don't imagine that anyone reading this is prone to or capable of the sort of sinister machinations of Bernie Madoff, but you are very wont to look for shortcuts to financial freedom. I recently sat down with a friend who was considering an "investment" that offered "15% annualized returns with protection of principal." I told her that I smelled trouble from a mile away and that it violated very basic principles of risk and reward. Looking at the pseudo-prospectus more closely, my fears only deepened. This was a scam. I warned my friend as loudly and emphatically as I could, but she ignored my warnings and proceeded with her original plan. I wish her the best but fear that she is in for some abrupt realizations about the laws of financial physics. Overconfidence may not make you a cheater in the same way Bernie Madoff was, but it may make you want to cheat the system in small ways: over leverage, excessive borrowing, a failure to diversify. Get rich quick and get poor quick are sides of the same coin; you're not so special that this rule doesn't apply to you too. 

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