THE MAIN STORY: CONFRONTING BIAS

Overview

Last year, at the Daily Journal’s annual meeting, Charlie Munger expressed how common it is to become envious of others.

We see a neighbor’s new car or gadget. Or we overhear a co-worker talking about their stock market gains in the past month, and we feel we’re missing out.

“The world is not driven by greed,” Munger said. “It’s driven by envy.”

No matter how much some people have, others will always have more. This is the essence of the “never enough” fallacy.

“I have conquered envy in my own life,” Munger added. “I don’t give a damn what someone else has. But other people are driven crazy by it.”

Let’s expand on Munger’s point about envy’s dangerous consequences and what investors can do about it.

The psychology

One of the most intriguing components of investor psychology lies in its counterintuitive nature. For example, investing in a drawdown typically has the highest potential to pay off.

“It’s waiting that helps you as an investor, and a lot of people just can’t stand to wait,” Munger has said, meaning sometimes the best action in investing is none at all.

Author, philosopher, and angel investor Naval Ravikant has said, “Don’t take yourself so seriously. You’re just a monkey with a plan.”

He means humans aren’t as rational as they think. We say we’ll buy low, sell high, be patient, and stick to our plan, yet these simple ideas are much harder to practice when there’s panic on the streets.

Greek Stoic philosopher Epictetus, who started his life as an enslaved person before opening his school of philosophy, taught that all external events are beyond our control.

But we’re responsible for our actions. The financial parallel: While we can influence others, we can’t control how our neighbors or competitors think or act. And we can’t control markets.

But we can control how we internalize what happens, the thoughts and beliefs we hold, and the lessons we learn.

Understanding bias

Munger hinted at envy as a driver. A few others are common in the investing landscape:

• Anchoring, where a particular reference point influences an individual’s decisions, often includes placing too much importance on the short run.
  • In the short run, stock prices over-compensate in both directions. In the long run, they tend to revert to the mean.
• Action bias describes our tendency to favor action over inaction. Sometimes, we feel compelled to act, even if there’s no evidence that our effort will lead to a better outcome than doing nothing.
  • Author Morgan Housel describes this bias well: When markets move lower, the human inclination to act (usually sell) settles in.
• Choice overload, known as over choice, choice paralysis, or the paradox of choice, describes how investors get overwhelmed when presented with many options.
  • When a friend recommends we buy several stocks, it can be difficult to decipher through the noise and make a sound investment decision.
• The bandwagon effect, similar to herd mentality, aligns with Munger’s idea of envy. It relates to our habit of adopting certain behaviors or beliefs because many others do the same.
  • Wall Street Bets popularized this concept in 2020 and 2021, pushing up the share price of meme stocks.
• Cognitive dissonance describes what happens when we avoid conflicting beliefs and attitudes. Humans often reject, debunk, or avert new information.
  • In investing, we can become attached to a particular stock or theme, which makes it hard to internalize new information. It can also create blind spots. Having your views confirmed is a powerful drug.

What to do about it

We can start by learning about these biases and where they might play out in our investment decisions.

Many sound investors keep detailed journals of their investment beliefs, feelings, and attitudes toward markets, companies, and sentiment.

Others rely on trusted partners to keep them in check and minimize the potential for blind spots or bias. Trust is a powerful currency.

Regardless, it’s critical to recognize that any number of probabilities can occur, and nearly every human can be susceptible to these powerful biases.

Consider a lesson from the book On Anger, in which Seneca draws on Fabius, one of Ancient Rome’s great generals, to teach a lesson from war:

“Fabius used to say that the basest excuse for a commanding officer is, ‘I didn’t think it would happen,’ but I say it’s the basest case for anyone. Think everything might happen; anticipate everything.”

Dive deeper

Morgan Housel’s bestseller The Psychology of Money addresses many of these common biases quite well.

Here’s Trey Lockerbie’s We Study Billionaires interview with Behavioral Finance expert Gary Mishuris.

Investors, we’d love to hear from you. How do you manage behavioral biases?