Thursday, October 21, 2010

Fighting confirmation bias

As humans, we all prefer hearing things we already more or less agree with... depending on your politics, you'll probably intuitively prefer to listen to left-wing, right-wing, or "sensible center" speakers, for example. In addition (the actual "confirmation bias") if we hear some things confirming our previous beliefs, and some contradicting them, we're more impressed and likelier to retain the agreeing (and thereby agreeable!) ones.

As an investor, that's not the attitude that's going to prove most helpful to you (unless you're so psychologically fragile that you desperately need confirmation... but then, maybe you shouldn't be an investor in the first place!-). If you've already decided to invest in XYZ (and even more if you are already invested in it, since the "endowment effect" makes you value more what you already own), hearing one more good pitch about why XYZ is a great investment isn't going to help your decision-making that much. The most helpful thing would be hearing a pitch against XYZ: maybe the author makes some points you hadn't thought about, points out some iffiness in the financial statements that you might have overlooked and can prompt you to re-check them in a focused way, and the like.

Hearing your beloved XYZ praised to the heavens reinforces your self-worth and makes you feel happier and more self-assured, but in general it doesn't help your investment strategies and tactics anywhere as much as the painful task of hearing XYZ dragged to the floor and trampled upon. So, fight your confirmation bias! If you have limited amounts of time and attention (and, who doesn't?!), they're better invested in trying to puncture your tentative investment thesis than in looking for psychologically-satisfying confirmation that, yes!, you are a genius (as you always suspected, after all) for thinking of putting some money into XYZ in the first place.

This goes for strategies (how do I generally regulate my investment choices and timing) as well as for tactics (what do I buy, when do I sell, &c). Me, I'm essentially a "value investor" at heart, focused on fundamentals and on getting bargains that Mr Market is currently down upon -- so, I owe it to my portfolio to research and ponder the contrary theses of momentum investing and other technicals and market-timing oriented approaches, as well as the "pure growth" enthusiasts for which "price is no object", differentiation is "diworsification", and so on. Whether such study will turn my whole strategy and character on their heads is iffy, but if I set myself to the task with a critical and dutiful attitude, it can at least give me ways to correct some excessive enthusiasm for a "too pure" approach.

And, what do you know, it has -- just like pondering Graham's ideas about balanced allocation turned me away my initial enthusiasm for an "all stocks, all the time" Peter Lynch-ish approach (so I now stick with a no-worse-than-25/75-allocation rule), so did sufficient focus on Lynch, Motley Fool, &c, convince me to "pepper" my mostly-defensive stocks portfolio with 1/4 to 1/3 of carefully selected "growth" bets, for example (more of that anon...).

I still have to grok the charm of the technicals, though... and, I decided Investors' Business Daily is not worth the bother (I loathe their politics, but then I don't like the WSJ's ones any more... but, the latter I read, as the politics is easily skippable and what I get from what's left is not technoblabbering on stocks -- it's information, facts, pointers and opinions about businesses, a much better value for my money and time!-). I'm still at it (starting with the "Dow Theory", which, whether it works or not;-), at least makes more sense to me than most other chartisms... maybe only because it's been around for over a century!-).

If you're a technical/momentum &c trader by instinct, let me suggest you similarly owe it to yourself and your portfolio to get good, continuing exposure to "the other side(s)" -- value investing, mostly. Start with Graham...!-)

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