Our brains have a wonderful, weird ability to make quick sense of the world through mental shortcuts. Yet, those shortcuts often fail us when it comes to money and investing.

For instance, investing is one activity where outcomes are not always obvious thanks to uncertainty. You can make the right decision and still lose money. You can also make the wrong decision and profit. So our mind fills in the blanks in a way that makes sense of it all. The result, however, can leave a false impression of the impact of skill and luck — both good and bad — on investment results.

A 1983 study by Thomas Gilovich suggests that it happens quite often. His study looked at how gamblers rationalized their success and failure from betting on football games. They were asked to record their thoughts about the outcome of bets under the guise that it would improve their betting later in the season.

Gilovich found that gamblers accounted for their wins and losses differently. It turns out, gamblers burned more mental energy to explain a loss compared to a win. Continue Reading…

Quote for the Week

It is very hard to think against the crowd, especially when the crowd is practically universal and unanimous in thought and emotion. When a man lifts his voice in chorus with a thousand other voices, singing nobly on a hillside, he will feel confident and exalted, at least until the song is ended, whether or not his actual circumstances warrant the feeling. Or try another shaky metaphor: when Galileo announced that the sun stood still and that the earth moved around it, virtually everyone with any interest in the subject agreed wholeheartedly that he was either crazy, wicked or both. This opinion was shared by both educated and uneducated. We should hesitate to label any of them as stupid, because if we had lived in those times that would almost certainly have been our scornful opinion too. — Fred Schwed Jr. (source)

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Quote for the Week

Real investment risk is measured not by the percent that a stock may decline in price in relation to the general market in a given period, but by the danger of a loss of quality and earning power through economic changes or deterioration of management. In the five editions of The Intelligent Investor I have used the example of A&P shares in 1936-1939 to illustrate the basic difference between fluctuations in price and changes in value. By contrast, in the last decade the price decline of A&P shares from 43 to 8 paralleled pretty well a corresponding loss of trade position, profitability, and intrinsic value. The idea of measuring investment risk by price fluctuations is repugnant to me, for the very reason that it confuses what the stock market says with what actually happens to the owners’ stake in the business. — Benjamin Graham (source)

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Quote for the Week

I’ve been an advisor to a couple of endowment funds. I was on a finance committee on one of them for quite a while. We had an outside advisor who set up benchmarks and suggested managers and hedge funds that would supposedly outperform, and so forth. The committee would work on this very seriously. These were smart, successful people, about a dozen, with a range of expertise. They would debate long and hard about how to allocate the assets — how much to emerging markets, how much to bonds, and so forth. And they’d fine-tune it from time to time, but mostly it didn’t make much difference. I found it difficult to persuade them that all this cerebration was a waste of our time. — Ed Thorp (source)

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