Do not be swayed by emotions, objective evaluation is key to investment
Common Psychological Misconceptions: Simple Association Bias, Overconfidence Bias, Authoritarianism, and Group Identity Bias
Combined from Munger Academy.
If you invest time and money in something, you will consider whether there should be a return on your investment. To some extent, life is like a game of poker, even if you have a good hand, you must learn to choose to quit at the right time. People need to learn to make fewer mistakes than others, and how to correct mistakes faster when they do make them.
Simple Association Bias
Peter Bevelin wrote that we are born with some preferences. We try to seek some pleasant excitement, get close to things that make us happy, and stay away from things that cause pain. To illustrate this, Peter Bevelin shared an example:
A supplier took a customer named John to the best steakhouse in town for dinner, and afterwards, the supplier voluntarily paid the bill. As a result, the supplier left a positive impression on John. Whenever John needs to purchase new supplies, he chooses this supplier. This shows that humans tend to act based on their emotions and feelings rather than cold facts and logic.
Bevelin further explained that people can influence their decision-making style by associating products, services, people, investments, or other situations with things they like. Many times, we buy products or make investments simply because we associate them with positive things.
It is no wonder that advertisers or politicians link what they want to convey with things we like and avoid associating themselves with negative events. This also explains why companies and politicians try to use negative words to describe their competitors and lead people to associate their competitors with things they dislike.
As investors, we must remember this principle. Just as many investment managers are good at promoting their charm and abilities. Even if you like a particular investment manager or a company's management team, it does not mean that we should invest in them or blindly adopt their investment advice.
Bevelin also pointed out that people generally do not like to deliver bad news. If someone is the bearer of bad news, people tend to have a negative view of them. For example, in "Antigone," a messenger is worried about his safety because he knows the king will be unhappy with the bad news he brings. Regarding delivering bad news, Buffett said that those working with him should think about it and disclose bad news promptly. Because people like Buffett least want to see bad news covered up, as this could lead to even greater losses.
Peter Bevelin's shared technique is to counteract misjudgments influenced by simple associations by conducting a comprehensive evaluation. Associating certain stimuli with pain or pleasure does not mean that the stimulus will cause the same pain or pleasure in the future. Therefore, people should be encouraged to immediately tell you bad news. Individuals are not inherently good or bad, just because we associate them with positive or negative things.
Furthermore, people's perceptions of something will change based on how that thing is framed.
If you invest time and money into something, you will start to think about whether there should be a return on your investment. In a way, life is like a game of poker, where even if you have a good hand, you must learn to choose the right time to fold. People need to learn to make fewer mistakes than others, and how to correct mistakes faster when they do occur. One method is rationality, by evaluating real benefits, probabilities, etc., to solve problems. Another approach is to assess the subconscious psychological factors. Lastly, Munger suggests using a checklist, applying key models from psychology, reviewing them, and considering the comprehensive effects of interactions, as well as how they play out in specific situations. Ultimately, people need to remember that in investing, thinking and rationality are superior to action and emotion.
Superresponse Tendency to Rewards and Punishments
Peter Bevelin quotes Charlie Munger in the book, "The iron law of nature is that you get what you reward for. If you want ants to come, you put sugar on the floor. Therefore, what we should do is seek what is favorable to us and avoid what is punished." From this, he introduces the psychological bias of "reward and punishment." We learn from the consequences of our actions what is right and what is wrong. Therefore, beneficial or pleasurable behaviors are often repeated. Once these behaviors are reinforced, they solidify, become stronger over time, and eventually become habits.
The British writer Samuel Johnson said, "The force of habit is weak, so it is often imperceptible, but once it is felt, it is invincible." In this regard, he shared a story told by Charlie Munger related to the New York Police Department.
At that time, the amount of pension was based on the salary level of the last year of work. So, some police officers in their final year of work cooperated with each other, trying to falsify their working hours and wages, such as setting a rule of working one thousand extra hours in the last year to maximize the final year's salary. Absolutely no one felt ashamed of such a plan because everyone hoped to benefit from it. Munger stated that they quickly felt entitled to do so. Everyone had done it before, and now everyone was doing it, so they continued to do so.
Bevelin believes that this is also closely related to investment. When people start making money through investments, they think they are geniuses and become overly optimistic adventurers. Then, when they see some failures or start losing money in stocks, they become overly pessimistic and averse to risk. People tend to overreact to recent experiences, just like children would not dare to touch a stove that might become hot again For example, retail investors who have lost a lot of money in biotechnology stocks are unlikely to buy another biotechnology stock in the future because of this negative association. Equally important, good outcomes do not necessarily mean that we made good decisions. Adverse consequences do not necessarily mean that we made wrong decisions.
If you are a manager, leader, or parent looking to motivate good behavior and deter bad behavior, Beverlin suggests that pleasant experiences should be divided into several parts, while painful experiences should not be divided. For example:
Have you ever been to a birthday party where children's gifts are wrapped in many different boxes? Giving rewards usually makes people feel better. The feeling of receiving $50 twice is better than receiving $100 once; the feeling of losing $100 once is better than losing $50 twice.
Similarly, we prefer a series of experiences that improve over time. Beverlin has many points worth remembering about the "reward and punishment" psychological fallacy. He says that praise is more effective in changing behavior than punishment, and encouraging the right things is better than criticizing the wrong things. Secondly, we should link incentives to performance and the desired outcomes to ensure that they understand their own performance. Generally, bad behavior should come at a high cost.
When corporate managers consider executive compensation, they can aim to create a company that maximizes long-term shareholder value. As a result, executives who own a large number of stocks and have worked for many years are incentivized to think long-term. Although managers' compensation mainly depends on stock options that appreciate due to short-term price increases, they are motivated to drive short-term performance. Beverlin also states that reward measures should be based on individual performance, not solely on the time the person has spent in the organization. When a company adheres to a structured or hierarchical system, employee promotions are solely based on their years of service in the company, which will severely undermine employees' work enthusiasm.
Furthermore, do not let money be the sole motivator, as rewards themselves can change employee behavior. When employees achieve success, we commend them, thereby increasing their motivation. However, if money rewards are the only way to encourage employees, it will inevitably make employees feel deeply controlled.
Self-interest and incentive bias
Blaise Pascal once said, "We are generally more convinced by the reasons we discover ourselves than by those given to us by others."
Beverlin once shared a story. The organizers of a tennis tournament needed funding, so they contacted the CEO of Transcorp to sponsor the event. The CEO asked how much money the event needed, and the organizers replied $1 million. The CEO said no, that's too much money. Then the organizers responded, saying that not only can you attend the event, sit in the honor seat, but you can also stand next to a member of the presidential family and present the awards. How about that? The CEO gladly accepted Obviously, people always do what is in their best interest. There is a classic saying that you should never ask a barber if you need a haircut. Everyone, including lawyers, accountants, doctors, real estate agents, consultants, salespeople, media, etc., may have biases due to motives that benefit themselves.
However, what benefits others may not benefit oneself. Brokerage advisors are often "salespeople" who may persuade you to buy things you don't really need, which is very common in the financial services industry. It is also worth mentioning the "incentives" on Wall Street. Wall Street wants you to take action and keep trading because they earn spreads and transaction fees from your continuous trading. They earn high commissions when you participate in overpriced or overly hyped new hot IPOs. Therefore, if you want to change someone's behavior, you can try to change their motives first.
Benjamin Franklin once said, when persuading others, talk about interests, not reasons. Directly telling someone what to do may not be wise because most people act according to their own will. Warren Buffett has also said that he hopes every subsidiary manager operates their business in the way they think is most suitable. He will never tell subsidiary managers which suppliers to use, and similar things. In general, this is Berkshire's practice. Therefore, the key point is that we need to always consider the interests and interests of others and start from there to change their motives.
Tendency of Overconfidence
Most people naturally think they are special. They believe that bad things that happen to others will not happen to themselves. Bevlin wrote that most of us believe that we will perform better, be more honest, smarter, have a better future, have a happier marriage, be less likely to be harmed, etc., than ordinary people. However, in fact, we often overestimate our abilities. People tend to put higher probabilities on expected events. Optimism is good, but a little reality is better when making important decisions.
Related to this, investors often attribute the returns in investments to their own skills, while attributing the losses to bad luck. Experiments show that when successful, most people attribute it to their excellent abilities. However, we do need to be aware of the psychological bias of overconfidence and realize that overconfidence can lead to unrealistic expectations and make us prone to making wrong investment decisions. Bevlin wrote that everyone needs to recognize their limits. Don't let your "self" determine what to do, but be keenly aware of shortcomings and potential problems, establish safety margins, and promptly develop action plans when situations deteriorate.
Due to people's overconfidence, they may be more easily deceived. Richard Feynman once said, the first principle is that you cannot fool yourself, and you are the easiest person to fool. Bevlin wrote that we deny and distort reality to feel better, especially when reality threatens our own interests. Austrian psychologist Sigmund Freud once said that believing in illusions is because they can relieve our pain and make us enjoy happiness On the contrary, if we only want to hear what we want to hear, deny many pieces of information that are inconsistent with our own beliefs, deny unpleasant news, then we are unlikely to become great investors because the world we see is not real. Refusing to acknowledge flaws will not make these things disappear, and truly bad news is more worth hearing than good news.
Imagine thinking about the world in a very simple cause-and-effect way. If X happens, then Y will happen. For example, if interest rates fall, then stocks will rise. However, the world, especially the market economy, is never as simple as we hope. In fact, there are many factors that influence the development of things, and we may not be able to reduce them to just one variable. This reminds people to always remain humble, not to be overly confident, as no one can predict what will happen in the future.
Oscar Wilde once said, the public has an insatiable curiosity about everything. Benjamin Graham wrote that we do not like uncertainty and meaninglessness. But it is important for people to accept the fact that the world is fundamentally uncertain. When people are most fearful and uncertainty is highest, that may be the best investment opportunity. Most people want to wait for the storm to pass, for the future to become clearer. By then, quality investment opportunities have already passed.
Reciprocity
There is nothing more indispensable than returning kindness, as no one will believe in an ungrateful person. Imagine, when someone does something very kind to us, we feel indebted to that person. So, we tend to repay others in the same way for everything they have done for us. I believe that people are naturally inclined to give without expecting anything in return. After a long period of giving, they may find that they receive a return of value tenfold in some way.
In his book "The Joy of Compound Interest," Gautham talks about the "kindness connection." Gautham has built good relationships with people he has worked with. When these people need help in the future, Gautham also lends a hand. Once, a person who had interacted with Gautham in the past warned him about some unknown events happening within the company. Therefore, before the company's financial situation became unstable, Gautham sold the company's stock. It was because of Gautham's past act of kindness that someone gave him a warning to avoid losses.
It can be seen that whether others are kind to us depends on how we treat them. Benjamin Graham also talked about Warren Buffett's way of dealing with things. At Berkshire, about three-quarters of the managers are financially independent. They do not have to work for Berkshire, but they still choose to do so. This is because Buffett never interferes with the work of these managers, but allows them to have ownership of their work, making them feel respected, with no one monitoring their every move, and no one criticizing them afterwards. Instead, they have control over everything. As a result, they appreciate Buffett's way of doing things and work even harder to make great things happen, in order to repay Buffett In addition, Bevlin also emphasizes that people do not want to feel guilty inside. If we do not allow others to give back to us, we will be disliked by others. Therefore, if you have helped others in some kind way, be generous in accepting others' feedback in the future. When feedback is presented in a personalized or unexpected way, it is most effective and very fascinating. If someone gives you something completely unexpected, that person will definitely leave a deep impression on you.
Adherence to Authority and Group Identity
Many investors, including myself, tend to somehow learn from the buying behavior of other well-known investors. When we see an investor we deeply admire buying a large amount of stocks, out of trust in them, we may follow suit without conducting extensive research. Of course, this may not be a problem for us, but in some cases, it may also cause trouble.
Authority bias is common when advertisers use celebrities to endorse their products. For example, Nike's success is partly due to their collaborations with top athletes like Michael Jordan and Tiger Woods.
In investing, we always face uncertainty about the future, so we turn to so-called investment experts. If someone is not familiar with the details of investing, they may blindly believe the opinions of certain "experts," prompting them to purchase obscure financial products. It can be seen that some people mistakenly regard others' opinions as authoritative simply because those opinions sound good, and this tendency to adhere to authority can lead to mistakes in behavior.
American philosopher Eric Hoffer said, "When people are free to do what they want, they usually imitate each other." People tend to believe what others believe and do what others do. If others avoid something, we are more likely to avoid it too. If others approve of a certain product and show their love for it, we are more likely to follow suit and purchase that product.
Furthermore, in order to gain a sense of group identity, most managers choose to use conventional management methods to avoid making unconventional decisions, as this would make them stand out and even seem foolish. In this trend, the economic market will see very irrational things happening. Buffett once said that as often happens on Wall Street, there will always be fools following investment trends. When we see a group of people doing something, we are more likely to imitate them. Even if the investment prospects are unbelievably good, or the numbers are completely irrelevant or meaningless, people will still blindly follow without hesitation. This is why Bernie Madoff was able to reap high returns year after year, even though his so-called investment strategy was impossible to achieve.
When people become wealthy by doing irrational things, they do not care about internal logic, let alone making decisions after careful consideration. When the majority of people in a group are doing the same thing, we are highly likely to do the same, which can lead us to become overly confident because we believe that the choices of the majority must be correct.
Buffett stated, "We will not find solace in important people, outspoken people, or a large number of people agreeing with our views." Benjamin Graham once said, have the courage to draw conclusions from facts using knowledge and experience. Regardless of others' hesitations or differing opinions, as long as you are confident in your judgment, take action Nowadays, social media is rampant, making it easy for people to fall into groupthink, which will only limit your creativity and eventually blur the line between yourself and others. For example, social media algorithms may identify your user profile and use it as a basis to push content that aligns with your views and interests in front of you. As a result, your thinking will gradually solidify, making it difficult to view things from a multi-dimensional perspective