Your investment style may be stuck in a bad grove in a changing world

Investment psychology

The hobgoblin at work

Our approach to investing may have worked in the past. That doesn’t mean it will work in the future.

The world is changing. John Templeton, one of the 20th century’s greatest investors, advised flexibility: his Maxim 19. “Never adopt permanently any type of asset, or any selection method. Try to stay flexible, open-minded, and skeptical. Long-term top results are achieved only by changing from popular to unpopular the types of securities you favor and your methods of selection.”

A look in the mirror

Can we honestly say we don’t recognize any of the following in our approach to investing?

  • We have remained consistent for a number of years in our approach to investing;
  • We don’t seek out and read about other investment approaches;
  • We don’t actively seek out contrary evidence or views about investing;
  • We typically read articles and books that are consistent with our point of view;
  • We don’t read articles that offer a contrary view;
  • We tend to remember things that agree with our views and forget things that don’t;
  • We surround ourselves with people who share our view;
  • In our experience it’s easy to find people to say ‘yes, you’re right’. It’s hard to find people to say, ‘no, you are wrong’;
  • We discuss things with friends who may be too polite to disagree with us;
  • When we talk to people who disagree, we tend not to listen to understand, but to listen to prepare to reply;
  • We don’t encourage others to offer contrary views;
  • We are preprogrammed to believe the status quo won’t change;
  • We are preprogramed to believe that things that haven’t happened before won’t happen.

Our own hobgoblin

“A foolish consistency is the hobgoblin of little minds” are the often quoted words from Self-Reliance, the essay by the American philosopher and essayist, Ralph Waldo Emerson. The essay is Emerson’s plea for people to open their minds to new ideas, avoid preconceptions and false consistency.

There’s an explanation for this human weakness. As Daniel Kahneman, a behavioral psychologist, explains: “The operations of associative memory contribute to a general confirmation bias.” He goes on: “A deliberate search for confirming evidence, known as positive test strategy, is also how System 2 tests a hypothesis. Contrary to the rules of philosophers of science, who advise testing hypotheses by trying to refute them, people (and scientist, quite often) seek data that are likely to be compatible with the beliefs they currently hold.” (Kahneman, Thinking Fast and Slow 2011) p81.

Kahneman has said: “Ideas become part of who we are. People get invested in their ideas, especially if they get invested publicly and identify with their ideas. So there are many forces against changing your mind. Flip-flopping is a bad word to people. It shouldn’t be. Within sciences, people who give up on an idea and change their mind get good points. It’s a rare quality of a good scientist, but it’s an esteemed one.”

Yes, we can do something about it

There is something we can do about this hobgoblin. As I see it, the first step is to be aware of the problem. And somehow, you have to keep reminding yourself about it. Even writing this post is a good personal reminder.

I am constantly trying to explore new ideas. In the last ten years I’ve made an effort to understand and apply behavioral psychology to my approach to investing. I’ve tried to learn about discounted cash flow approaches to valuing stocks. In the last three years I’ve made an effort to understand company investment in intangibles and their impact on the income statement and company balance sheets. In that regard I am trying to learn about networks, platforms and other company sustainable advantages in the digital economy. Each of these has caused me to give up on some old ideas. I’m currently trying to see what I can learn from systematic factor investing which intuitively jars me.

Every thoughtful investors has to develop a sense of their own weaknesses. Being stuck in the mud with our current views is one of them. It is common for every investor to think that what they have learned about investing and their approach to investing is the only way to go. The problem we have is that what has worked in the past may not work in the future.

Seek out contrary views

And sadly we often only see information that confirms our views don’t see information that challenges our view. It’s not that the contrary views aren’t there. We just ignore them. This is a common behavioral bias. We have to actively seek out contrary views.

Other posts on investment psychology

This post is part of a series. Readers are invited to read Investment psychology explainer for Mr. Market – introduction  This will give you a better understanding of some of the terms and ideas and give you links to other posts in the series.

To read more deeply on the subject of the confirmation bias see Chapter 14. Changing our minds in the Motherlode.

Want to dig deeper into the principles behind successful investing?

Click here for the Motherlode – introduction.

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