Biases That Skew Our Thinking

Biases that skew our thinking
BY MICHEL PIREU, 15 DEZEMBRO 2015, 06:23
Picture: THINKSTOCK
A DOZEN biases, adapted from A Dozen Things I’ve Learned About the Psychology of Investing, by Tren Griffin:
• Framing bias. "The best example of narrow framing I can think of is the use of pro forma earnings. Essentially, this is a
company turning up and saying, hello I’m lying to you, these are the earnings I didn’t make, but I’d be jolly grateful if we
could all just pretend I did." — James Montier.
Our brains only have so much cognitive capacity, so humans suffer from inattentional blindness. When people are told to
focus on earnings before interest, taxes, depreciation and amortisation (also known as bullshit earnings), they often don’t
see a lack of genuine profit and poor cash flow.
• Denial bias. "Denial ain’t just a river in Egypt." — Mark Twain.

Richard Feynman put it this way: "The first principle is that you must not fool yourself — and you are the easiest person to
fool." The tulip bubble and Exchange Alley (1600s), The South Sea bubble (1700s), emerging markets and the railroads
(1800s), the Gilded Age, the New Era, commodities and LTCM (1900s), the tech bubble and subprime lending (2000s) …
The excesses being built up in the markets today will eventually revert just as they have done at every other peak in market
history. The only question, to which no one has the answer, is exactly when and why.
• Hindsight bias. "We’re really crummy at forecasting the future." — Daniel Kahneman.
It’s so difficult, isn’t it, to see what’s going on when you’re in the middle of something. It’s only with hindsight we can see
things for what they were, although seldom as they are. Arguably the best thing you can do to overcome this bias is to write
down the reasons you do things and their results. If you try to keep track mentally, you run the risk of excluding your
mistakes.
• Loss-aversion bias. "People are really crazy about minor decrements down." — Charlie Munger.
While what is in the past is what an accountant calls "sunk", it is hard for people to think that way. If we’ve spent resources
on something — whether it’s as small as a ticket to a bad movie or millions in an investment that’s not working out —
we’re inclined to stay the course so as not to waste what we’ve already spent. Investors will watch a stock price drop to zero
as the more it drops, the harder it becomes to sell.
• Confirmation bias. "What a man wishes, so shall he believe." — Demosthenes.

In doing due diligence and research on a stock people see what they want to see. Conspiracy theorists believe in a
conspiracy because it’s more comforting. Jewish bankers are not in control. The truth is more frightening. Markets are
rudderless.
• Overconfidence bias. "Overconfidence precedes carelessness." — Toba Beta.

A Morgan Stanley executive describes overconfidence bias as what lies behind Wall Street’s "sell-side" profits (if investors
were not overconfident, Wall Street profits would plummet). To paraphrase William Gibson: "What you need to remember,
with these guys, is that they don’t know what they don’t know. They’re wildly overconfident. That’s part of the mythology
that surrounds market traders … they believe they can do something they don’t know how to do, and not even realise
they’re bullshitting themselves. It’s a special kind of gullibility."
• Overoptimism bias. "Most of us view the world as more benign than it really is, our own attributes as more favourable
than they truly are, and the goals we adopt as more achievable than they are likely to be." — Daniel Kahneman.
Nothing works better than having a margin of safety. Especially as you grow older, "returning to go" financially is a risk
well worth avoiding.
• Cascades/herding bias. "(People) think in herds; it will be seen that they go mad in herds, while they only recover their
senses slowly, and one by one." — Charles Mackay.
Although we’re often unconscious of it, we love to go with the flow of the crowd. When the herd picks a winner, our
individualised brains start to shut down and enter into a kind of groupthink or hive mind mentality. But it doesn’t have to be
a large crowd or the whims of an entire market; it can be a small group, like a family or an investment club. Fortunately, as
Benjamin Graham said: "You are neither right nor wrong because the crowd disagrees with you."
• Anchoring bias. "In the absence of any solid information, past prices are likely to act as anchors for today’s prices." —
James Montier.
Anchoring is a tendency to grab on to inputs just because they are available.
• Illusion of control. "If people want high numbers, they’ll roll the dice really hard, but when they want lower numbers, they
roll them very gently." — Michael Mauboussin.
Once people pick a stock, they immediately become more certain that the pick is wise when logic should tell them
otherwise. This can result in a failure to sell when it should be sold.
• Projection bias. "Our minds influence the key activity of the brain, which then influences everything; perception,
cognition, thoughts and feelings; they’re all a projection of you." — Deepak Chopra.
As individuals trapped inside our own minds, it’s often difficult for us to project outside the bounds of our own
consciousness and preferences. We tend to assume that most people think just like us. This cognitive shortcoming often
leads to a related effect known as the false consensus bias: we assume that a consensus exists when there may be none. It
can also create the exaggerated confidence one has when predicting a winner.
• Cognitive dissonance. "Never try to teach a pig to sing; it wastes your time and annoys the pig."
Festinger’s cognitive dissonance theory suggests that we have an inner drive to hold all our attitudes and beliefs in harmony
and avoid disharmony (or dissonance). It refers to a situation in which conflicting attitudes or beliefs produce a feeling of
discomfort leading to an alteration in one of the attitudes or beliefs … often giving rise to irrational and even maladaptive
behaviour.
To paraphrase Harley Bassman: "Woe to the investor who fails to heed the admonishment: ‘Don’t fight the Fed.’ Yet we
have seen this movie before; we know that the calm financial landscape the Fed has engineered will at some point become
roiled. But this is not a dire prediction for calamity, it is just a notification that risk and return are tightly linked, except for
those rare periods when investor emotion overwhelms financial realities."
http://www.bdlive.co.za/opinion/columnists/2015/12/15/biases-that-skew-our-thinking

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Biases that skew our thinking

BY MICHEL PIREU, 15 DEZEMBRO 2015, 06:23

• Denial bias. "Denial ain’t just a river in Egypt." — Mark Twain.

• Confirmation bias. "What a man wishes, so shall he believe." — Demosthenes.

• Overconfidence bias. "Overconfidence precedes carelessness." — Toba Beta.

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