Better Investing Requires A Broad Perspective
Homo economicus is a myth, of course. But it's a very seductive myth, especially as and when we relate the concept to ourselves. We like to think that we're rational actors carefully examining and weighing the evidence in order to reach the best possible conclusions. Oh that it were so.
In 2006, researchers randomly mixed and labeled news stories from a single, separate news source as coming from four different outlets - Fox, CNN, NPR and the BBC - and showed them to a random sampling of readers. Significantly, the very same news story attracted a substantially different audience depending upon the network label. Thus, for example, conservatives chose to read stories labeled as being from Fox while liberals ignored them, no matter their actual source and content. In other words, the exact same story with the exact same headline was deemed readable or not solely based upon its apparent source. The conclusion is obvious, if unsurprising: "people prefer to encounter information that they find supportive or consistent with their existing beliefs." Therefore, people generally "wall themselves off from topics and opinions that they would prefer to avoid."
This research result isn't remotely surprising for anyone who has looked at decision-making, particularly with respect to investing. It shows classic confirmation bias, our tendency to see what we want to see and look only to sources that agree with our preconceived notions. Add in a bit of optimism bias and we jump to conclusions that we think are right far more often than they really are. That's why bleachers all over America are full of parents who are certain that their child is a prospective Hall-of-Famer (or a least a prospective college scholarship winner - all evidence to the contrary) and why venture capitalists are wildly overconfident in their estimations of how likely their potential ventures are to succeed. And because of our bias blindness, it is extremely difficult for us to see that there might be something wrong with our processes. Everybody else may be biased, but we are convinced that we have made a careful and objective analysis.
In related news, what Nobel laureate Daniel Kahneman calls the "planning fallacy" is our tendency to underestimate the time, costs, and risks of future actions while at the same time to overestimate the benefits of those actions. It's one reason why nearly every building project tends to have cost overruns. It's also why my week-end chores take at least twice as long as I expect and require three trips to Home Depot instead of one. It's why the end result isn't nearly as good as I expect.
These behavioral and cognitive biases constantly conspire to limit our ability to make good investment decisions and good decisions generally. Unfortunately, there isn't a lot we can do to deal with these issues, as Kahneman concedes. But if we're to have any chance of making good decisions consistently, we need both outside input and an "outside view." As Kahneman noted during a question and answer session I attended, our best chance of overcoming our inherent biases is for us to ask the best and smartest people we know to tear our ideas apart. We need substantial and meaningful input from those outside our in-group. We also need what Michael Mauboussin calls the "outside view." It requires that we expand the reference class beyond our comfort zone and our personal experience. We need a much bigger sample size from which to acquire data.
The way we're built makes it really hard for us to make good decisions. To have a reasonable opportunity to make good decisions, we need actively to consider and test opposing viewpoints. We don't like to think that we're wrong, but we are - a lot. As Jeff Bezos of Amazon insightfully expresses it, people who are right a lot of the time are people who change their minds. Information may be cheap, but meaning is expensive and elusive. If we are going to make better decisions in the markets and elsewhere, we need a much broader perspective and we need to be constantly refining and updating our viewpoints.