Charlie Munger (Trades, Portfolio) knows there is more to successful investing than reading financial statements (although doing so is, of course, also important). He has spoken at length on many occasions on the importance of understanding market psychology and how investors fall victim to the same cognitive biases over and over. In his famous 1995 speech, “The Psychology of Human Misjudgement,” he covered a number of these biases. Over the next few weeks, we will be taking a deep dive into several of these defects, examining where they come from and the dangers they pose to investors.
An unwanted superpower
“This is a superpower in error-causing psychological tendency: bias from consistency and commitment tendency, including the tendency to avoid or promptly resolve cognitive dissonance. Includes the self-confirmation tendency of all conclusions, particularly expressed conclusions, and with a special persistence for conclusions that are hard-won...According to Max Planck [one of the founding fathers of quantum theory], the really innovative, important new physics was never really accepted by the old guard. Instead, a new guard came along that was less brain-blocked by its previous conclusions. And if Max Planck’s crowd had this consistency and commitment tendency that kept their old inclusions intact in spite of disconfirming evidence, you can imagine what the crowd that you and I are part of behaves like.”
In other words, if even theoretical physicists, who are supposed to be completely objective and unemotional, can get stuck in a particular mode of thinking, then what hope can there be for players in the market, an arena that by its very nature is ruled by subjective and emotional forces? In such an environment, it is unsurprising that so many of us succumb to our own ossified ideas about how the world should look.
Being right doesn’t matter, being rich does
To make matters worse, voicing a particular opinion can cause further problems, as Munger explained:
“And of course, if you make a public disclosure of your conclusion, you’re pounding it into your own head. Many of these students that are screaming at us, you know, they aren’t convincing us, but they’re forming mental change for themselves, because what they’re shouting out [is] what they’re pounding in. And I think educational institutions that create a climate where too much of that goes on are…in a fundamental sense, they’re irresponsible institutions. It’s very important to not put your brain in chains too young by what you shout out. And all these things like painful qualifying and initiation rituals pound in your commitments and your ideas. The Chinese brainwashing system, which was for war prisoners, was way better than anybody else’s. They maneuvered people into making tiny little commitments and declarations, and then they’d slowly build. That worked way better than torture.”
Given this speech was presented at Harvard University, it is unsurprising Munger’s focus here is on educational institutions. But the same logic applies to all walks of life, of which the market is one. There are two reasons why this effect is especially pernicious. First, by voicing a particular point of view, you are reinforcing the validity of that opinion in your own mind. Second, by publicly taking a side in a particular argument (for example, by voicing a bullish or bearish thesis on a company), you tie yourself to that position.
In an ideal world, investors would be open to changing their minds when proven wrong, or when new evidence comes to light that contradicts their point of view. However, we all know this is not the case. Far too many investors are more concerned with being proven right than becoming rich. This leads to poor money and risk-management decisions and is a major reason why price and value become disconnected.
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