When (Not) to Trust Yourself

To be Skillful is to be able to accomplish a given task, directed towards seeking an intended result, with comfort and in the least possible time. However, an another important aspect of being skillful at something, and importantly to retain the skill with the changing times, is the ability to understand when not to trust your own skills and make necessary changes as we move along.

As an investor, discovering an investment psychology that suits our temperament and which is sound enough to beat the indices, when appropriately implemented, is akin to acquiring a professional skill. One of the major impediments in mastering that skill is learning to deal with the conflicting thoughts arising out of occasional disconnect between our investment philosophy and negative outcomes from individual investment operations. And how we deal with such discontents, over the long run, should determine if we manage to develop and retain the skill.

The underlying reason behind the disconnect could range from any limitation in our investment philosophy (or) simply an event where the process was right but outcome was negative due to some low probability external event. To be able to come up with a possible reason, it is important that we understand our typical response mechanism to such dissonant conditions. Eventually, a better understanding should lead us to either improve our investment approach (or), just as importantly, manage to not tread away from our investment philosophy when times are testing.

Cognitive Dissonance & Psychological Immune System:

Human beings normally tend to have a positive image of themselves. It could be argued that such a positive self concept evolved through centuries to enable us to have decent levels of self esteem and, in effect, lead us to maintain a healthy state of happiness. In short, it could be said that such a positive self concept is integral to leading a, psychologically, healthy life.

But when a human brain, which is wired to seek a stable state of self concept, is faced with disconfirming evidence, we are confronted with a realization that we might not be as good as we believe ourselves to be. Because disconfirming evidence indicates possible mistakes, which in turn could be taken as indicative as a sign of inability by the society. Thus when a positive self perception is faced with evidence suggesting possible mistakes a psychological conflict is triggered. This state can be considered as similar to unpleasant drive states like hunger, thirst and pain. Under such conditions, to reduce the dissonance and anxiety, a psychological immune system gets triggered and can potentially leave us vulnerable to psychological pitfalls.

Let me discuss three most common reactions triggered under such state and possible solutions suitable for investors to overcome such limitations triggered while investing.

Misperceiving the Past:

Memory plays an integral role in the way we deal with dissonance. It not only helps us remember the past without any considerable conscious effort but it also leads us to sometimes misperceive the past. When human brain is faced with evidence conflicting decisions from the past, our memory could lead us to tweak our ability to recall relevant facts in an effort to reduce the dissonance. In short, memory has the potential to not only help us remember - what made us happy in the past but also misremember an unpleasant experience for a pleasant one, if subjected to dissonance.

Antidote:
As an investor, this limitation of memory of occasionally misperceiving our past can be dealt by relying on journals and discussion records, where we try and answer every possible aspect of an investment operation while making the decision (Why I am buying into this opportunity? What do I expect going forward? What are key threats that could possibly work against us? Why did I invest only 3% and not 5-10%? etc...).

Seeking Selective Exposure:

A wise philosopher once said that one should keep both his eyes open before marriage and half shut afterwards. But reality seems to suggest that people do just the opposite - keep half shut before marriage and both open afterwards. How else could we explain the fact that quite a few people are blindly in love with each other only to file for divorce within a few years. The reason behind this phenomenon could be that they take selective exposure to the qualities of other person leading to disproportionate weighing of attributes.

Antidote:
For the lack of experience, I cannot comment on how we can go about overcoming this pitfall while choosing an appropriate partner. But as an investor, I think we could get into a habit of consistently looking for disconfirming evidence and seeking clarification in the form of counter evidence against it. (Darwin used to write up conflicting thoughts on a paper as soon as it struck him, as he believed that otherwise mind would get busy suppressing such contradictory thoughts).

It is easier said than done - but the beauty of the whole process is that the awareness itself can help one deal with it and also lead one to find better solutions suiting his temperament.

External Justification:

Everybody's life is a play, in which not only is all the world a stage for each one of us to act as we wish but is also full of prospective protagonist and antagonist. And one of the most common methods of dealing with dissonance, sometimes for better and sometimes not, is looking for the other people (or) external circumstances to play the role of antagonist in our play.

Antidote:
As an investor, bearing the cost for (perceived) mistake of somebody else is a deadly combination. Because then the whole mindset gets into deciding if we were lucky/unlucky and all those sort of things, which might be right sometimes but as a process might prevent us from learning through our mistakes and, simultaneously, progress. I think subscribing to Mr. Munger's 'Iron Prescription' can help us deal with this mindset to a great extent:

“Whenever you think that some situation or some person is ruining your life, it’s actually you who are ruining your life. It’s such a simple idea. Feeling like a victim is a perfectly disastrous way to make go through life. If you just take the attitude that however bad it is in anyway, it’s always your fault and you just fix it as best you can – the so-called “iron prescription” – I think that really works” - Charlie Munger

Conclusion:

Inspite of all the scientific progress that we have made during the last few thousand years, one of the greatest mystery still facing mankind is to his inability to completely understand the processes of human brain, which has its own set of advantages, making it far superior than other forms of life, but also fails us in understanding reality intending to maintain a positive self image.

The only way to learn to limit the effects of disadvantages is to develop a sense of inquiry into the conditions under which it might fail us. And that understanding, along with systematic solutions to limit the impact, would guide us as to when not trust our mental processes.