5.1 Humility and pride
Article 2 discussed how mindfulness generates humility, which helps us make better investing decisions. Evidence suggests that many investors operate in a haze of pride and overconfidence. Like the children of Lake Wobegon, who are all above average, many investors ignore the bell curve and assume they are somehow smarter than most other market participants. Benjamin Graham said,
- “The investor’s chief problem – even his worst enemy – is likely to be himself.”
This over confidence occurs in part because a rising market tide will float even investment picks riddled with leaks. Some investors confuse a bull market with their own investing prowess. Warren Buffett said,
- “The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money.”
When I was investing in the booming late 1990s, everyone assumed they were a stock picking genius, even though a chimpanzee could have done just as well. Others such as Ben Carlson have written how most investors are deluded about their investing capabilities. Carlson notes,
- “…there are also a large number of investors who are delusional, because they’re making the assumption that they’ll be the ones who can [beat the market], when in fact only a very small number of people can. There’s a seemingly endless supply of investors out there who try again and again to outsmart the markets, but only end up outsmarting themselves.”
The pride and overconfidence that comes so easily to humanity falls firmly on the greed side of the fear/greed dichotomy discussed in Article 4.1. Mindfulness of our greed (and other emotions) checks innate pride and allows us to approach the same problem with humility instead. If you’re not sufficiently mindful to imagine this humble condition, it’s nearly as useful to remember how investment markets work. On the other end of every stock and bond “trade” there is always someone who is assuming the opposite action is the smart choice at that same moment. Even if you might be trading with a computer algorithm, which will retain the stock you just sold for only milliseconds, there is still a programmer somewhere who thinks your on the dumb side of that trade. And who is to say for sure they are wrong?
In western mindfulness terminology, our innate tendency toward pride is fueled by our egos. Eckhart Tolle talks about ego a great deal in “A New Earth” and other places. Ego is normally defined as a sense of self-worth or self-importance, but in a mindful sense, ego is more expansively about self-identification. Our egos relate every thought, every memory, every interpretation, opinion, viewpoint, reaction, and emotion to the internal story we have built over time to define our own identities. We even tend to relate every object, person, or occurrence we encounter to our ego. Is that my car or your car? Is that my stock or yours?
However, these egocentric questions are irrelevant to the reality of any objects. A new Audi TT is still an Audi TT, regardless of whether you bought it or someone else did. The new car does not function any differently or have a different value because of its owner (although the owner’s habitats might degrade the car’s future value more quickly). Similarly, our investment decisions are egocentric, but 100 shares of TSLA is just a 100 shares of TSLA, with the same potential to grow or shrink in value, no matter who owns it. To view these objects otherwise, to view them relative to our egos, is to fundamentally fool ourselves. For this reason, Tolle speaks of ego as an illusion, which clouds our real understanding of objects such as investments as well as our own thoughts, opinions, and emotions. Mindful meditation helps us step outside this egocentric view and see the reality of our investment decisions, or anything else. In everyday language, mindfulness helps us be more objective and less subjective.
The power of ego
If this all sounds like spiritual mumbo jumbo for people who don’t have any common sense, it’s worth considering the degree to which intelligent people can fool themselves in the service of their egos. A stunning example of egocentric thinking is the issue of “autistic facilitators”. This was once a widespread method to help severely autistic children communicate. It involves a facilitator who holds the autistic child’s hand over a key board, which presumably allows the child to select letters to build words and even sentences. The first uses of autistic facilitators were very compelling. Through their facilitators, the child patients often appeared to be communicating complex thoughts and desires similar to normal children.
However, when autistic facilitation was subjected to blind scientific studies, the results were far less compelling. The simplest experiments involved showing the patients an object (like a ball) that was simultaneously concealed from the facilitator behind a partition. In this setting the patients showed little ability to name even simple objects through facilitated communication. Many experiments of this type were conducted. The America Psychological Association concluded that:
Highly trained facilitators who had elicited sophisticated answers from their patients in the past could no longer do so when they were prevented from knowing what the patients were being asked…The short version of this long story is that study after study showed that facilitated communication didn’t really work. Apparently, the positive results that had generated so much enthusiasm were the results of a subtle process in which well-intended facilitators were answering questions themselves – without any awareness that they were doing so. Based on the findings of carefully controlled studies of facilitated communication, the American Psychological Association issued a resolution in 1994 that there was “no scientifically demonstrated support for its efficacy.”
If you are interested in reading more, “A Passion to Believe: Autism and The Facilitated Communication Phenomenon” is one book on the subject. Despite the copious evidence that facilitated communication does not work, there is still a strong advocacy movement for this technique that is easy to find on the internet, as a quick scan of the Amazon reviews of this book shows.
This tragic story illustrates that we can delude ourselves to a shocking degree. In most cases, there is no reason to believe the facilitators involved had any motivation other than a genuine desire to help the patients; the facilitators had no significant monetary or other incentives to actively fool those around them. The facilitators were likely totally unaware they were the only source of the information communicated. The only reasonable explanation is that their egos, their strong desire to be personally involved, enabled them to conceal from themselves the origins of the false messages. If such fundamental self-delusion is possible, imagine the extent to which we can delude ourselves about our investment decisions, level of objectivity, and portfolio performance.
Beyond mindfulness as a philosophy, science explains that our brains evolved to process a bewildering array of sensory input from the world and efficiently make decisions to find food, escape predators, and select mates, among other things. Our brains use rules-of-thumb, or heuristics to make many of these decisions, which worked well in the past, but are less than ideal for many modern decisions. As a result, some heuristics are called cognitive or behavioral “biases”. Dan Ariely’s book “Predictably Irrational: The Hidden Forces That Shape Our Decisions” provides a good review of these innate cognitive or behavioral biases from the perspective of behavioral economics. “Thinking Fast and Slow” by Daniel Kahneman is also an excellent review of cognitive biases within a larger theoretical framework based on years of experiments.
There is a lot of clutter on the internet about cognitive biases, often with the same bias described by different names and the same name used to describe different biases. Here is an extreme example that tries to sort it all out. Some of these presumed biases only rise to the level of pseudo-science, while others are pretty well established and backed by experiments. Here are just a few of the more recognized cognitive biases that are commonly identified as impacting investing decisions:
- Confirmation Bias – Is the tendency for us to interpret evidence as a confirmation of our pre-existing beliefs or theories. For example, we might have a theory that utility stocks should perform better in a low interest rate environment. We then select utility stocks on that basis, while failing to notice that other sectors may be performing even better.
- Gambler’s Fallacy – Is the false notion that after flipping heads five times in a row, the next flip is more likely to be tails. No matter how many times you flip heads, the probability of tails in the next trial is still 50%. Similarly, if the market has dipped five days in a row, all other things being equal, the probability of the market going up the next day is still the same. Chapter 6 of Burton Malkiel’s famous “A Random Walk Down Wall Street” argues that stock price movements are essentially random, and the next price move cannot be predicted based on price history. This view is still hotly contested, at least in part because it is linked to the questionable efficient market hypothesis. However, there are other reasons to believe prices may often move essentially at random, even if markets are not efficient.
- Overconfidence Bias – Is our tendency for subjective confidence in our own judgments that is usually greater than our objective accuracy. For example, 80% of drivers rate themselves as having above average driving skills. Studies like this support the idea that egocentric thinking confuses investing decisions, as discussed above.
- Hindsight Bias – Sometimes called the “I-knew-it-all-along” effect, hindsight bias is the tendency to view past events as being predictable at the time those events happened. It is discussed extensively in “Thinking Fast and Slow”. When combined with overconfidence, hindsight bias deludes us that our future predictions of investment performance are validated by our false sense of the accuracy about our past predictions.
- Information Biases – These are a collection of biases that causes us to process information incorrectly. The “anchoring bias” is a tendency to rely too heavily on the first or most prominent information available when making decisions. Anchoring is related to the “availability bias”, where we tend to overestimate the importance of information that is most available to us, and the “recency bias”, where we focus on new events or data and overlook older data. So, investing decisions based on a prominent headline may ignore more obscure or older data that are equally important.
- Bandwagon and Projection Biases – These are two related biases about how we consider the opinions of others. The bandwagon effect is our tendency to adopt a belief as more people adopt the same belief, also sometimes called “group think”. Projection bias is our tendency to assume that others hold beliefs similar to ours, which means we may believe we can predict some of their actions when we can’t. If ten people tell you to buy a certain stock, you might develop the sense that it’s a sure thing, but that’s not necessarily a good idea without looking into the details yourself. Similarly, if you are nervous about the stock market, you may assume that others are nervous as well and decide to sell.
(Some people call the overconfidence bias an “optimism” bias, which is confusing. As I point out in Article 4.2, there is good reason to be generally optimistic about the future of the economy and stock markets. Optimism about the general future is different from overconfidence about our own skills or our chances of avoiding known systemic risks. For example, I can reasonably be optimistic about the long term future of the stock market, but I should not be overconfident that I can avoid temporary market declines better than other investors.)
“Loss aversion” is one more important behavioral bias that’s worth highlighting separately. Loss aversion is less about cognition and more about how our emotions impact our future behaviors. Studies show that we feel negative emotions from losses (the fear side of the dichotomy) about twice as strongly as the positive emotions from gains (the greed side). This biases us toward inaction (also sometimes called the status quo bias) and more timid choices, because we are so averse to strong negative emotions. For reasons discussed in Articles 4.1 and 4.2, mindfulness can successfully mitigate the loss aversion bias in our investing decisions.
The next article (Article 5.2) presents copious evidence that a wide range of actual investors find it very difficult to beat the market, for all the philosophical and scientific reasons noted above.