The photograph above, taken by German photographer Thomas Hoepker, is one of the iconic images of 9.11. The picture was taken at the Brooklyn waterfront on the afternoon of that infamous day twelve years ago. In Hoepker’s words, he saw “an almost idyllic scene near a restaurant — flowers, cypress trees, a group of young people sitting in the bright sunshine of this splendid late summer day while the dark, thick plume of smoke was rising in the background.” By his reckoning, even though he had paused but for a moment and didn’t speak to anyone in the picture, Hoepker was concerned that the people in the photo “were not stirred” by the events at the World Trade Center — they “didn’t seem to care.” Even though he published many images from that day, Hoepker withheld this picture for over four years because, in his view, it ”did not reflect at all what had transpired on that day.” Continue reading
We just celebrated the 68th anniversary of D-Day, and well we should. That day in western France was the pivotal day and the pivotal event of the 20th Century. As Omar Bradley pointed out, every man who set foot on the beaches of Normandy on June 6, 1944 was a hero – the men who took the cliffs to fight tyranny and took back a continent for freedom. I dare you to try to watch footage of and about that horrible, dreadful, wonderful day with dry eyes or a cold heart.
Here’s to the boys of Pointe du Hoc. In the words of Stephen Spender, these are men who in their “lives fought for life and left the vivid air signed with [their] honor.” Continue reading
If, as I believe, the small-cap premium is at least partly due to the inherent efficiencies of smaller companies, larger companies have inherent inefficiencies and these inefficiencies will be reflected by the markets. All of which brings me, via circuitous route, to a discussion of Apple. Continue reading
It is axiomatic in the investment world that as an asset class becomes more popular, it suffers from both falling expected returns and rising correlations. In other words, good trades get crowded and their advantages tend to disappear. This crowding happens because success begets copycats as investors chase returns. Mean reversion only tends to make matters worse. In effect, it results in “investing while looking in the rearview mirror” or, as per the title of William Bernstein’s fine new book, Skating Where the Puck Was.
The evidence suggests that this overcrowding is precisely what has been happening with respect to the Yale Model. Continue reading
Regular readers of this site know that I reference and write about what Nassim Taleb calls the narrative fallacy often. It is our tendency to look backward and create a pattern to fit events and to construct a story that explains what happened along with what caused it to happen. We all like to think that our decision-making is a rationally based process — that we examine the evidence and only after careful evaluation come to a reasoned conclusion as to what the evidence suggests or shows.
But we don’t. Continue reading
The Edge Foundation is an organization of science and technology intellectuals. Its main activity is a website, edited John Brockman. The site is an online magazine of sorts exploring scientific and intellectual ideas. The Edge motto is “to arrive at the edge of the world’s knowledge, seek out the most complex and sophisticated minds, put them in a room together, and have them ask each other the questions they are asking themselves.”
In recent years, Edge has posed an annual question to its members. The question and member answers are provided on-line and ultimately collated into a book. As you may have seen, this year’s Edge question is “What *should* we be worried about?” Since most Edge members are scientists, it shouldn’t be surprising that the answers generally focus on science and scientific issues. However, several answers have particular relevance to finance, the markets an investing. Continue reading
Tomorrow evening Duke and North Carolina will renew the best rivalry in sports via a basketball game on the Duke campus (ESPN, 9pm ET). As a freshman, Jay Bilas (now of ESPN) lined up for a foul shot in his first rivalry game next to then All-American and future NBA All-Star Brad Daugherty (and also a current ESPN-er), who looked over at him and said “I’m going to beat you like a rented mule.” That comment was astonishingly mild as these things go.
I first sat in Cameron Indoor Stadium as a student in 1978 and didn’t miss a home basketball game while I was enrolled at Duke. Every game was special – and wild. NBC came to Cameron to do the first national telecast from the arena on January 28, 1979 for a game against Marquette (I was there, of course) and insisted on a time-delay so the crowd could be censored if necessary. But Duke v. Carolina was and is something else entirely. Continue reading
I pay a lot of attention to the investment process. In that regard, every investor — personal or professional — ought to have a clear investment plan based upon appropriate personal considerations, goals and outlooks and every investor ought to stick to that plan unless and until something significant changes. But there is a crucial component of the investment process that gets surprisingly little attention: our investment default settings. We can use them when we aren’t sure what to do, when we’re deciding what to do, when our circumstances have changed but our plan hasn’t (yet), or when we’re just starting out.
The idea here is that we all have default settings — known and unknown, acknowledged and unacknowledged — and that those defaults greatly influence how successful we are and become. Having the right default setting in defined contribution plans make a big difference (more here). I would examine and apply my default settings across and throughout the entire investment process and even suggest that we need to look at our default settings as carefully as we look at anything else.
What follows are my suggested default settings. Your mileage may vary. Continue reading
Sunday may be the biggest unofficial American holiday of the year. The Super Bowl (XLVII) and its surroundings offer some pretty good lessons for investors too. Let’s look at seven (VII) of them. Continue reading
Pretty much since the day I wrote it, my Investors’ 10 Most Common Behavioral Biases has been the most popular post on this blog. It still gets a surprising number of hits all these months later. Due to the pioneering work of Daniel Kahneman and others, nearly everyone in the financial world acknowledges the reality of cognitive and behavioral biases and their impact on people, the markets and life in general. It’s a very popular subject.
Unfortunately, we don’t think that we are susceptible to them personally.
As I have noted before, we all tend to share this foible — the bias blind spot, which is our inability to recognize that we suffer from the same cognitive distortions and behavioral biases that plague other people. As one prominent piece of research puts it:
We cannot attribute [our adversaries'] responses to the nature of the events or issues that elicited them because we deem our own different responses to be the ones dictated by the objective nature of those events or issues. Instead …. we infer that the source of their responses must be something about them.
In other words, if we believe something to be true, we quite naturally assume that those who disagree have some sort of problem. Our beliefs are deemed merely to reflect the objective facts because we think they are true. Our thought process goes something like this:
I’ve thought long and hard about it [biases leave no cognitive trace, after all] and I’m convinced I’m not a bigot. Some of my best friends are __________.
Of course, that line of thinking doesn’t convince anybody else. The research again:
We are not particularly comforted when others assure us that they have looked into their own hearts and minds and concluded that they have been fair and objective.
Of course not — they’re biased (but I’m not). It’s the same kind of thinking that allows us to smile knowingly when friends tells us about how smart, talented and attractive their children are while remaining utterly convinced with respect to the objective truth of the amazing attributes of our own kids.
The problem is even more acute when the “answer” is counter-intuitive, and good investing is often wildly counter-intuitive (it’s really hard to sell when we’re euphoric or buy when we’re terrified, for example). So what can we do to try to minimize our own behavioral biases? We can start, of course, by admitting what is obvious based upon the research and the data but so very hard to concede – we are all continually susceptible to cognitive and behavioral biases.
That’s great, so far as it goes. But even though there is a great deal of research into the reality of these biases, there isn’t a lot written about what we might do to deal with them and counteract their impact. That’s partly because there isn’t a lot we can do (as even Kahneman readily admits).
In his 1974 Cal Tech commencement address, the great physicist Richard Feynman talked about the scientific method — a careful and consistent process designed to root out error – as the best means to achieve progress. Even so, notice what he emphasizes: “The first principle is that you must not fool yourself–and you are the easiest person to fool.”
Even so, I am not eager to admit defeat. Therefore, I humbly offer the following ten suggestions to try to deal with our cognitive and behavioral biases. I hasten to emphasize that I offer them tentatively and without any assurance of success. Dealing with bias is extremely hard. Proceed with caution. But also bear in mind this insightful comment from Jeff Bezos of Amazon: people who are right a lot of the time are people who often change their minds. Much of dealing with our biases is simply being willing and able to change our minds when its appropriate. It’s hard, but the reward is huge — being right a lot.
- Focus on the Data. As I have said repeatedly (and I’m not alone in this), focus on the data. As my masthead proclaims, I strive for a data-driven perspective and a data-driven process. That isn’t easy to do, sadly. We relate better to stories and are all too willing to believe and concoct narratives of various sorts to support our latest nonsense, but it’s a worthy aspiration and commitment nonetheless.
- Actively Seek Out Contrary Data and Conclusions. A remarkable universe of discoveries in psychology and neuroscience demonstrate that our preexisting beliefs skew our thoughts and even color what we consider our most dispassionate and reasoned conclusions. This tendency toward so-called “motivated reasoning” helps explain why we find groups so polarized over matters about which the evidence seems so clear. In other words, expecting people (including ourselves) to be convinced by the facts is contrary to, well, the facts. Factor in behavioral biases (such as the ever popular confirmation bias, optimism bias, in-group bias and self-serving bias) and it’s easy to see (at least conceptually) why we can get it so wrong so readily. Our tendency is to look for and consider only those views that correspond to our own – which goes a long way towards explaining the popularity of Fox News and MSNBC, for example, while also explaining why the viewers of each of those networks tend to think that only the other side has it all wrong. If we are going to be able to see things a bit differently, we need to seek out and consider sources that look at things differently.
- Build-In Accountability Mechanisms. We need (relative) objectivity if we are going to succeed in investing and in life unless we are extremely lucky. Having an accountability partner or (better yet) a competent and empowered team is particularly important due to our great ability to spot what’s wrong with everybody else (if not ourselves). It also means taking and dealing with criticism seriously. Even welcoming and encouraging it. It shouldn’t be surprising to see so many people who experience great investment success suffer indifferent performance or even failure subsequently (Bill Miller and John Paulson, for example). The more success and power we achieve, the easier it is to believe the hype. Accountability mechanisms that are maintained and honored can help to undercut that.
- Focus on Process. Accountability is more effective when it’s part of a consistent, careful, clear and clearly defined process. We all recognize that the outcomes in many activities in life combine elements of both skill and luck. Investing is one of these. Especially troublesome is our perfectly human tendency to attribute poor results to bad luck and good results to skill. It’s a lead-pipe-lock that we’re going to err and err often in the investment world. If we are to succeed with any measure of consistency, we need carefully crafted plans with screw-up contingencies built-in together with a commitment to regular re-evaluation and a rescue plan in the event of major catastrophe.
- Test and Re-Test. No matter how good our process is, we need also to assume that we have made errors and set out actively to find them by testing and confirming everything possible. Once we have decided that a given view is correct or committed to a particular course, confirmation bias has a tendency to take over. Planning to be lucky and believing that psychological realities don’t apply to us is a lovely (if arrogant) thought. But it’s not remotely realistic. Keep testing and looking for ways that you’re wrong.
- Avoid the Noise. Distinguishing signal from noise can be agonizingly difficult. Given the sheer amount of stuff competing for our attention, eliminating distractions unlikely to provide substantive benefit will improve the likelihood of our success. CNBC is fun and all, but how often does it make us smarter or better?
- Take a Tip from Attorneys. I often refer to myself as a recovering attorney, and there is a great deal about the practice of law that is frustrating and silly. But one excellent technique I learned from my time in that profession is to argue the other side’s case. Understanding and even appreciating a contrary point of view is helpful to our own thinking and can provide a good check on the coherence of our own viewpoints. Understanding and seeking support for the opposition’s best arguments is a powerful learning tool. We might even decide that – gasp – mistakes were made (almost surely by someone else, of course).
- Keep Track of Your Mistakes as Carefully as Your Successes. We all tend to trumpet our successes and downplay our failures. I highly suggest that, at least within your circle of influence and with those to whom you are accountable, you carefully track and analyze your failures, readily apparent or not. Sometimes these mistakes will be the result of bad luck. But often you will find correctable errors or even errors in your process. Doing so also helps with #10.
- Take Your Time. The more experienced and successful we are, the easier it is to take short-cuts. Experience is what allows us to apply useful short-cuts, of course, but it’s important to remember that all behavioral biases and ideologies provide mental short-cuts of a sort too. For big decisions, at least, make sure to take the time to connect each and every dot. When I was in law school I often refereed basketball games for extra money. Many situations were repeated time and again with the next action and the right call seemingly foreordained. It was always difficult to avoid anticipating the call — blowing the whistle based upon what was highly likely (perhaps almost surely) to happen rather than waiting to see what actually happened. Surprises happen on the basketball court with remarkable frequency. They happen in investing too.
- Try to Stay Humble (no matter how successful you are). Even though it takes a healthy amount of self-confidence to be an investment success, arrogance and certainty are frequent enemies of continued investment success. Your accountability partners can and should help here, of course. Spouses are especially expert at promoting humility. You will screw up and screw up often. Remind yourself of that reality often as you continue to look for where your most recent failings took place.
It’s really hard to deal with (much less overcome) our cognitive and behavioral biases. These tentative steps are offered to try to do so but I don’t promise anything like success. Yet these steps (or an ongoing commitment to implement the concepts behind them) should put you well ahead of most everyone else.
And that’s a pretty good thing indeed.