Thomas Gilovich looks at why we form questionable or inaccurate beliefs and why we hold onto them. Through research and examples, he identifies cognitive biases we all share that distort our beliefs and decisions.
Quote for the Week
Almost all of the information in the investment management business is oriented toward purchase decisions. The competition in making purchase decisions is too good. It’s too hard to outperform the other fellow in buying. Concentrate on selling instead. In a Winner’s Game, 90 percent of all research effort should be spent on making purchase decisions; in a Loser’s Game, most researchers should spend most of their time making sell decisions. Almost all of the really big trouble that you’re going to experience in the next year is in your portfolio right now; if you could reduce some of those really big problems, you might come out the winner in the Loser’s Game. — Charles Ellis
James Rea mailed a computer printout of his stock list to Ben Graham. Rea had never met Graham. He had no clue Graham existed. At least, not until clients said he should read an article by Graham.
It turns out Rea’s list was filled with the type of stocks Graham wrote about for years. His letter eventually led to a phone call from the legend, which led to a meeting, then a research collaboration, and finally a private investment fund.
After some debate, Rea and Graham agreed on 10 stock criteria to base their research around. The period covered was 1925 to 1975.
Graham’s goal was simple:
To try to buy groups of stocks that meet some simple criterion for being undervalued — regardless of the industry and with very little attention to the individual company.
He wanted to bypass time-consuming analysis for a more diversified “group” approach to stock selection using a few simple metrics. And their research backed up the idea. Continue Reading…
Quote for the Week
In 1915, while just a beginner on Wall Street, I suggested that the firm recommend a low-price stock, the Computing-Tabulating-Recording Co. But my employer, a conservative fellow, pointed out that the company’s bonds weren’t covered by its assets. He said, ‘How can you touch such a speculative stock?’ And I returned to my desk a very chastised young man. Years later the public company changed its name to IBM.
He was wrong about the stock. But he was right in terms of an overall investment policy. Look at what could happen. A man could buy a stock like that at, say, $40 a share, and it goes to $100. Then people would say, ‘Don’t be a fool. Take the profit. Trees don’t grow to heaven, etc., etc.’ So he sells out, and then spends the rest of his life watching IBM go up and up, while looking vainly for another IBM. To make a fortune in one stock you almost have to be an insider. For mere traders, there are very, very few IBMs. That’s the vital point. — Benjamin Graham (source)
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)