An interesting week we are going through right now. The stock markets are finally providing a bit more entertainment value. Giving us a good test on another (nasty) bias that makes us do dumb things with our money: Illusion of skills.
All of us have limited access to the workings of our minds and as a result, we know less about ourselves than we feel we do; still, we are not the only ones that might be suffering from this.
An entire industry that largely appears to be built on the illusion of skills is the Investment Industry; particularly, those self-proclaimed “stock-picking-experts”.
Often, millions of shares of a single stock change hands in a day and most of the buyers and sellers know that they have the same information; nevertheless, the primary reason for their exchange of stocks is due to their difference in opinion:
The buyers think that the price is too low and likely to rise, while the sellers think that the price is high and likely to drop.
Why do both buyers and sellers think that the current price is wrong?
What makes them believe that they know more about what the stock price should be than the market? Sadly for most of them, that belief is an illusion.
Extensive research has shown that for a large majority of the individual investors, taking a shower and doing nothing with their stock holdings would have been a better policy than implementing the ideas (fed by their “skills”) that bubble up in their conscious minds.
Research shows that trading is quite hazardous to one’s wealth. On average, the most active traders had the poorest results, while those investors who traded the least earned the highest returns.
Nonetheless, these facts that challenge our assumptions are often not assimilated by us as our minds do not comprehend them and this is particularly true of statistical studies of performance which provide base rate information which we ignore when they clash with our personal experiences.
Mind you, the process of becoming less stupid is quite different from the process of getting smarter.
Getting smarter means learning things that we had no prior knowledge of; starting from average, and then going up, whereas, becoming less stupid is realizing that some of the knowledge that we have is wrong, and then starting below average, and then trying to get back on par.
How to overcome cognitive illusions
By learning to recognize situations in which mistakes are likely and trying harder to avoid significant mistakes when the stakes are high.
Naturally, we all want to feel like we are making good decisions and the easiest way to achieve this is by making friends with people who agree with us. However, surrounding ourselves with agreement does not teach us anything new; on the contrary, it just reinforces bad ideas and falsehoods.
We can only become less stupid at investing if we surround ourselves with people who think that we are wrong and who would point out that our beliefs are not true because they are the ones who are in a different emotional state than we.
And in case you think that attending a conference/seminar might help in the acquisition of investment skills, be aware of the First Law of Financial Conferences:
People think they go to conferences to acquire knowledge, but oftentimes, it is just to have their beliefs confirmed and reinforced by others.
Wrong objectives, a waste of money, and a waste of time.
And can you tell me why some people do pay hundreds of dollars to attend a conference—to hear someone talk about their book—when they could have just paid $20 for the book? What’s up with that? Curious to read your views in the comments box below.
Lastly, before I take my leave, and before you believe whatever you read (this blog included), keep in mind that it is not whether those experts/authors are skilled; instead, it is whether their world is predictable. I know the world that I live in is clearly not.
“He was so deadly, in fact, that his enemies would go blind from over-exposure to pure awesomeness!” — Po, in Kung Fu Panda
“An unbiased appreciation of uncertainty is a cornerstone of rationality.” — Daniel Kahneman
“It’s far more profitable to sell advice than to take it.” — Steve Forbes
Had a good read right after dinner.
Thanks Colleen, I hope knowing that you know less than you always thought did not upset your digestion.