Article by Vintage Value Investing
What if learning how to be a successful investor was more than learning about finance and economics?
What if other fields of study played a major role in how we become successful investors?
Charlie Munger: Invert And Use “Disconfirming Evidence”
Charlie Munger is considered to be one of the best investors and thinkers alive today. His thoughts and statements on investment research, investment psychology, and general rational behavior are often incredibly insightful. Anyone can learn something from this billionaire investor and philosopher. Q2 2020 hedge fund letters, conferences and more If you’re looking for value Read More
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The truth is that they do. And one widely successful investor, Charlie Munger (vice president of Berkshire Hathaway), believes that human psychology is just as important as economic when it comes to investing.
Although he has no formal training in psychology, he relies heavily on some of the concepts in the field in order to make solid, informed investment decisions.
In fact, 6 of those concepts are worth considering by any serious investor who is truly looking to make a solid return in the market today.
So, what are the 6 secrets of psychology that Munger applies to the world of investing?
Let’s explore each of them together.
1. The Bandwagon Effect
Concept: This is a phenomenon in which the rate of uptake of beliefs, ideas, fads and trends increases the more that they have already been adopted by others. As more people come to believe in something, others also “hop on the bandwagon” regardless of the underlying evidence.
In his book Influence: The Psychology of Persuasion, psychologist Robert Cialdini describes how powerful this effect is: There are signs throughout Arizona’s Petrified Forest National Park that tell visitors: “Your heritage is being vandalized every day by theft losses of petrified wood of 14 tons a year, mostly a small piece at a time.”
Cialdini designed an experiment by removing the sign from a specific path in the park to measure any differences it might make. The path with no sign had one-third less theft than the path with the sign. Visitors interpreted the sign’s message as permission. Put differently, visitors thought it was “normal” to take small pieces of wood, because so much was stolen every year.
Implication on Investing: We hear a hot new tip fresh off the press that everyone is jumping on so we ignore our values or principles we use to make informed investment decisions and follow the crowd – sometimes into a disaster.
Concept: This bias causes us to deny the reality because the truth makes us too uncomfortable. We paint a distorted image of the situation to convince ourselves that it’s not really that bad and to make ourselves feel better in spite of the facts.
Implication of Investing: We hold on to a bad investment too long in hopes that things will turn around and end up in a deeper hole later on than the one we could have left had we gotten out of the situation when reality suggested we do so.
3. Over-Influence by Authority
Concept: This is the idea that something must be true because someone in authority is saying it is. This bias results in us denying what we know to be true against our better judgment because someone we deem to have better skill or knowledge says something contrary to what we believe. We then go with what the authority says rather than what the facts indicate.
Implication on Investing: Some guru says something that we believe. So, we use our investment money to follow someone else’s strategy that could backfire or not contribute overall to the specific goals we have determined for ourselves.
4. Liking Distortion
Concept: This bias is liking oneself and one’s own system of beliefs above those of everyone else. This causes us to think the way we see things is better than the way others do so we tend towards our own inclinations in spite of the facts at hand.
Implication on Investing: We choose investments based on our own beliefs without considering someone else’s point of view which leads to limited perspective and, oftentimes, limited returns.
5. Disliking Distortion
Concept: This is the opposite side of the coin of liking distortion. Whereas liking distortion overemphasizes our ideas above those of others, this bias undermines the ideas of others beneath our own. Since the person giving the facts is different from us, we reduce the validity of what (s)he is saying and tend towards our own views rather than the ideas the person is suggesting.
Implication on Investing: We miss the opportunity to learn something that will help us progress in our goals. We stay stuck by refusing to change or make improvements to our sometimes faulty plans.
6. Stress-Induced Mental Changes
Concept: This is when adrenaline and other hormones kick in and we react based on the fear and anxiety we feel mentally and physically rather than on the truth of what we know.
Implication on Investing: We make rash decisions based on the market rather than on principle. We either buy something we shouldn’t buy, or in most cases, sell something we shouldn’t sell. The loss from this bias alone is enough to disrupt what are otherwise shrewd investment plans and strategies.
Although Munger uses even more psychological secrets than those mentioned in this post, these are some basic ones to definitely keep in mind as you progress toward your investment goals.
Be sure to avoid the movement of the crowds and accept reality as it is. Remember to think for yourself but not so much so that you overvalue your own opinion and/or devalue the advice of others. And most importantly, make your decisions based on strategy and principle, not on stress.
By keeping these psychological secrets at hand when you invest, you are sure to avoid many of the common pitfalls new investors make. And you also raise the possibility that you will see positive returns on your investments in a shorter amount of time than those who ignore these principles.