CHAPTER 2

Self-Image and Self-Worth

Okay, so we now know that while we can trust our senses to help us determine the future trajectory of a ball we can't trust them to help us predict the future trajectory of stocks. But we can deal with that, because we're smart, right?

In fact, we know we're smarter than the average investor, so we can be pretty sure that we will make money on the markets. After all, if we didn't think we were going to make money on the markets we wouldn't be investing, would we?

It's time to start the tour bus again, because we've just strayed into the counterintuitive world of investors' beliefs about themselves. Only we'd better be careful, because the bus driver almost certainly thinks they're a better than average driver, along with over 90 percent of other Americans. We are woefully overconfident about our investing abilities, and we don't even know it.

THE INTROSPECTION ILLUSION

I have two left feet and a cloth ear, which makes me peculiarly unsuited for engaging in any activity that involves music, a sense of rhythm, or the ability to count a beat. Imagine a baby giraffe trying to dance in roller-skates. On ice.

Despite this sad lack of musical ability I don't hold it against myself, and my own sense of self-worth isn't particularly damaged by this gaping hole in my abilities. Like most reasonably well-adjusted people, I take a sensible approach to activities I'm not very good at—I avoid them if at all possible and make a joke of them when I can't. Whenever I have cause to think about my own abilities I do so in terms of the things I think I'm good at, rather than those I think I'm bad at and I certainly don't start a catalog of my attributes by considering my modern dance skills. And I don't doubt you do the same. Go on, make a list of things you're bad at and then consider whether you care about them?

This is typical of everyone, because no even moderately self-aware adult is going to choose to spend a lot of time doing something that they know they're bad at, and which is going to provide an unremitting sequence of embarrassing experiences. We actively edit our own lives, and simple self-selection ensures that we'll spend most of our lives doing things we're at least average at and which provide a positive stream of feedback, which makes us feel good about ourselves. It's unsurprising, then, that when most of us think about ourselves we generally have a positive self-opinion—after all, most of us have mainly positive experiences to remember once we escape the clutches of our parents, who usually insist on us doing things they'd never consider for themselves. Like modern dance lessons. Not that I'm bitter or anything,

In its most extreme form this preference for favoring one's self is known as self-serving bias and, at it's worst, it can lead to a complete failure of introspection. Sufferers will blame their failures on external influences that they couldn't control and insist that their successes are purely due to their own innate skill. This isn't an attractive quality at the best of times, but when applied to investing it's likely to be severely wealth limiting.

Of course, when we do think about ourselves we don't actually realize that our positive self-regard is generated by our careful selection of activities that make us feel good. We generally recall our triumphs and carefully avoid remembering our failures. This is known as the introspection illusion, and it's quite probably the reason that we don't recognize we're biased, even though we agree everyone else is, why we trade too much and lose a load of money by doing so, why we keep our very worst stocks and sell our best, and why we think we can predict the future, even though the evidence shows we couldn't predict the present and that mostly we can't even remember the past. For very good psychological reasons most of us are positive thinkers, especially about ourselves, but this has a terrible affect on our ability to manage our investments. It's good for our health, but rotten for our wealth.

BLIND SPOT BIAS, REVISITED

The work of Emily Pronin and Matthew Kugler¹ I touched on in the previous chapter suggests that blind spot bias—our knack of thinking we're not biased but that everyone else is—is a side-effect of the introspection illusion. When we think of ourselves we think of someone who is above average—and, after all, we have a generally positive view of our experiences. So, we have inflated expectations of our own abilities and when asked to compare ourselves with other people we think that we're better than them, so we end up believing that we can rise above our brain's constant stream of trickery.

Famously, more than 50 percent of drivers think that they're above average—a clear statistical impossibility and an equally clear case of self-serving bias. Of course, many well-known “facts” are actually urban myths but this one isn't, and is actually backed up by some real research by Ola Svenson,² who showed that 93 percent of American drivers thought they were better than the other crazy bozos on the road. At least the other 7 percent were honest, although they're probably not people you want to nominate as your designated drivers on a night out.

However, the introspection illusion can lead to far worse problems than a skewed view of our driving abilities. This brings us to one of the most famous experiments in the history of psychology, Stanley Milgram's electrocution test.³ It touches a nerve, in more ways than one.

The experimental setup had two participants who couldn't see each other, with one asking questions and the other answering. Every time a question was answered incorrectly the questioner applied an electric shock to the unseen responder, and the size of the shock was increased each time a question was answered incorrectly. After a while, the victim, understandably, started pleading to stop the experiment but a white coated researcher would then instruct the questioner to continue to turn up the electricity—and they nearly always did, applying shocks to a level that could have caused significant, long-lasting harm.

Or at least they would have, had the experiment been real. In fact, the “victim” was a stooge who was acting a role and the whole experiment was designed to test the willingness of the actual participants, the people doing the shocking, to defer to authority figures. In a whole series of experiments, under different circumstances, Milgram was consistently able to replicate these results: over and over again people would apply shocks to pleading, begging victims simply because they were instructed to do so. These results were, quite literally, shocking for what they revealed about our willingness to defer to authority figures.

These types of experiments aren't allowed anymore because of the psychological harm that they can cause to participants, but they're scarily reminiscent of real-world situations where people seem to collectively lose sight of the nature of morality: Milgram was working at a time when Nazi Germany was still prominent in many peoples' minds. This was just the start of a whole host of experiments suggesting that we have an instinctive tendency to defer to authority, even when those authority figures are false. How often do people suspend their critical judgment in order to follow some stock market guru or other?

When a follow-up study was carried out on the Milgram experiment, looking at what people thought they would do if placed in the same situation, the vast majority believed that they would find the inner strength to resist and stop the experiment.⁴ You probably think the same thing—I certainly do. Unfortunately, we're both almost certainly wrong. This is blindspot bias in action. It's frightening what we can be induced to do in general life, but applied to investing it's potentially disastrous.

ROSE-COLORED INVESTING

So, the introspection illusion will cause us to be overoptimistic about our abilities to overcome our biases and our overoptimism will typically lead us into overconfidence. This turns out to be a particular problem when we engage in activities where we don't get timely and clear feedback, as we only remember our successes and tend to conveniently overlook our failures. Obviously, if you're so bad at dancing you fall over every time you shuffle onto the dance floor you won't persist unless you're oddly determined, exceptionally stupid, or possess an unusually forceful mother, but as long as you do reasonably well some of the time you're quite likely to persist in believing you're above average at the pasodoble and a dab hand at the tango.

Of course, doing reasonably well some of the time is a fair description of our results when we go investing. Even if we're the worst stock-picker in the history of the known universe we will, purely by chance, occasionally happen upon a successful investment—and, as we've seen already, many investors don't actually know how well their portfolios have been doing against the broader market—a clear case of base rate neglect—so we'd expect them to tend to remember their successes, forget their failures, and generally be way too optimistic about their abilities to pick winners.

All of which is exactly what Brad Barber and Terrance Odean⁵ found when they analyzed data from Internet traders. Barber and Odean's work is famous within the behavioral finance community because they've pulled some extraordinary findings out of data relating to the way people behave when they're given a computer, an Internet connection, and an online trading account. To summarize: we're not rational. But we knew that already. What we didn't know was how much it costs us.

One of their studies showed that most traders gave up money most times they transacted. By and large the stocks they sold proceeded to outperform while the ones they bought underperformed. On top of this, traders pay brokerage fees to make these trades, handing over tons of cash every year to the financial industry in the process. In fact, it's quite hard to get an exact handle on how much money is passed from active investors to financial institutions each year, but in aggregate it's in the billions of dollars. Come on, where did you think the finance industry makes its money? It's from us.

Clearly, people wouldn't be making these trades if they didn't think they would make more money by doing so but the evidence shows that they're misplacing their faith in their own abilities. Another study by Markus Glaser and Martin Weber⁶ suggests that the more overconfident the investor the more they tend to trade, which is roughly equivalent to the worst drivers spending the most time behind the wheel. Overconfidence is a bane for investors, and it's a hard habit to kick, even for experienced traders, but we all need to take off the rose-colored trading spectacles and get real.

PAST AND PRESENT FAILURES

Overoptimism as a source of our monetary failings is hardly a new finding. As far back as 1915, a stockbroker using the pseudonym Dan Guyon⁷ showed that people were able to lose money even while the stocks they were buying rose by 65 percent. Worse, they actually thought they were making money! They constantly mistimed their trades, buying after stocks had risen and selling after they'd fallen, thus missing out on the majority of the potential gains.

Then, in the 1930s and 1940s, an American economist named Alfred Cowles⁸ started looking at tip sheets and other public forecasters. Rather than blindly believing the sweet-tongued blandishments of these snake charmers he did some real analysis and attempted to use their forecasts as a basis for making investment decisions. Analysis of these results revealed—surprise, surprise—that the forecasters had absolutely no forecasting ability and were permanently biased to an optimistic view, by a factor of 4 to 1. As the study remarked:

Indeed, Cowles went on to remark, dryly, that the only way of using tip sheets to make money in the markets was to find the very worst ones and then do the exact opposite of what they recommended!

The inability of investors to capture positive market returns isn't just ancient history, either. Similar findings have been shown more recently—a Dalbar, Inc, study⁹ showed that the difference between market returns and investor returns varied between 300 and 500 percent: in some years active investors made only a fifth of what they would have done had they simply stuck their cash in an index tracker and went on vacation all year. The problem, as the Barber and Odean study revealed, is that we just trade way too much, because we're relentlessly overoptimistic about our ability to pick winners, and don't track our successes and failures properly, because that would force us to address our introspection illusion head on. Unfortunately, we're not as good at investing as we think we are. Although, as it turns out, one way of possibly reducing the problem is to make yourself really, really miserable.

DEPRESSED BUT WEALTHY

There are indications, as the Cowles quote suggests, that we're designed to prefer good news to bad. It turns out that one way of improving your investment returns is to make yourself really, really depressed. I really, really don't recommend this, but the so-called depressive realism effect has been shown to remove our rose-colored investing spectacles and to cause us to face the world as it really is. Obviously, trading off our mental health in order to improve our investment returns is a bit of a bum deal, but the finding adds further weight to the idea that we're permanently biased towards good news and away from bad, and that this leads us into all sorts of financially unwise behavior.

Why we're so addicted to believing the best about the world is still a bit of a mystery, but one theory is that if we really faced up to the contingent uncertainty and general awfulness of existence then we would be unable to function properly. Another theory suggests that it's an unintended byproduct of consciousness: self-awareness means we understand the limits of our own mortality and that, in turn, means that we need to be unrelentingly optimistic in the face of certain death. All of this is a bit depressing, especially if we want to be successful investors, although, ironically, believing this would probably improve our investment returns.

Our overconfidence and over-optimism seem to be built on our natural need to bolster our self-esteem and feelings of self-worth, traits that may well be fundamental to our general well-being. So, once again we find that a behavior that is natural and healthy in the context of normal life will undermine our investments and, once again, we need to find ways of restraining this behavior in an investment context.

Overconfidence is, in fact, difficult to completely eradicate, but the research indicates that this is one area where experience does tend to help a bit. A behavioral finance study by Maximilian Koestner, Steffen Meyer, and Andreas Hackethal¹⁰ shows that as we become more experienced investors we tend to churn our portfolios less, and this will tend to result in improved returns, exactly what the Barber and Odean research would suggest. This is the sort of result we ought to expect because any moderately self-aware person should eventually notice that the stocks they buy don't usually do very well and the ones they sell are successful: it's cause and effect, more or less, and realism will slowly seep in.

Obviously we would be better served learning this lesson early, and doing so by learning from the experiences of others before incurring our own losses. However, failing that, it's better that we learn through small losses rather than big ones. And a bit of realism always helps.

DISPOSED TO LOSE MONEY

Unfortunately, as the Koestner research identifies, experience doesn't eradicate all biases and one such issue seems to be a tendency that Barber and Odean also identified in their erratically overconfident Internet traders—our preference for selling our winners and keeping our losers, a behavior known as the disposition effect.

This finding is one of the oldest in behavioral finance, and again can be traced back to the work of Amos Tversky and Daniel Kahneman.¹¹ Roughly speaking, we can think of our disposition as our fundamental set of innate qualities—the behaviors we're born with, or at least those we demonstrate regularly and consistently. Disposition is to be contrasted with situation—the stuff that is dependent on the particular situation we find ourselves in. So, disposition is permanent, situation is temporary. Unfortunately, in the modern world, we often seem to get a bit confused about which is which, with some damaging consequences.

We discussed one example of the disposition effect earlier in the chapter, in the infamous Milgram experiment. Our innate disposition is to defer to authority, so we will tend to obey figures who exude a certain kind of confidence, regardless of their actual knowledge or abilities. This has led to a whole range of sad outcomes, everything from doctors chopping off the wrong leg to commercial airlines flying into mountains in perfect visibility and cavalrymen charging gun emplacements armed with the equivalent of small pointy sticks.

An experiment by Lee Ross, Teresa Amabile, and Julia Steinmentz¹² has even shown that people think that game show hosts are more intelligent than the contestants, because they know the answers to the questions. Somehow they manage to ignore the fact that the hosts have the answers in front of them! Another related behavior is known as the beauty effect, where we think that an attractive person is also likely to be intelligent. These problems are triggered by the misapplication of social cues and, as the evidence suggests, are very, very difficult to overcome.

This confusion between disposition and situation—not all men in white coats in hospitals are doctors—is a problem known as the fundamental attribution error. It's nastily tied up with the introspection illusion, blind spot bias, and deferral to authority and helps explain why we tend to listen to stock market gurus, celebrity CEOs, and other supposed experts. Sadly, they can't predict the future any better than we can, they're just reading off their cue cards.

LOSS AVERSION

When the behavioral economists Hersh Shefrin and Meir Statman¹³ looked at the disposition effect in investors they identified a particular type of irrational behavior—a tendency to sell winners too quickly and to hold losers too long, something they refered to as “an aversion to loss realization,” which is obviously closely related to the finding that Internet investors tend to trade away their gains. These days, we typically refer to this, a little more simply, as loss aversion.

Loss aversion, as its name suggests, is a strong inclination to avoid losers, which in the stock market tends to mean avoiding taking a loss—that is, we will try and avoid selling a stock while we're losing money on it. Like all of the other biases we've met this isn't just an investing issue and can be found in many other areas of life. In fact, the strength of the effect was demonstrated in a neat study of professional golfers by Devin Pope and Maurice Schweitzer.¹⁴ Each hole on a golf course has a “par” score, which is the number of strokes you're expected to take to get the ball in the hole. If you take more than the par number of strokes you make a “bogie” or, in investment language, you take a loss. On the other hand, if you take less than the par number of strokes you make a “birdie,” or make a profit.

The researchers hypothesized that the players would suffer from loss aversion and be more worried about losses than gains. They analyzed the relative success of golfers when putting to avoid a bogie or achieve a birdie and found, as they suspected, the players were far more successful at avoiding losses than they were at making gains when making their final putts (which, for non-golfers, is the part where you try to get the ball in the hole). Interestingly, on the final day of the tournament, when what really mattered were the golfers' positions relative to each other, as this determines their prize money, this effect disappeared.

The same par-bogie effect appears to apply to investors. Even professional investors demonstrate it, as Peter Locke and Steven Mann¹⁵ showed. The experts hold losing investments longer than winning ones and their average position size—the number of stocks they hold—is larger for losers than winners. We all hate taking losses, and will grimly hang on to duff stocks in the hope that they'll rise to our buying price. Because we want to register gains we will also tend to sell our winners simply because they've gone up, regardless of whether or not they remain excellent homes for our money. This is madness, but it applies in all sorts of situations and seems to be a problem that investors find almost impossible to overcome. The net effect, as with so many other biases, is to reduce our potential gains significantly, as those studies from Cowles and Dalbar we looked at earlier show.

ANCHORED

One reason we're so reluctant to take a loss is related to our issues with self-esteem. As long as we can delay accepting a loss we can pretend it's not real and avoid challenging our beliefs about our innate investing ability. We also sell our winners for a similar reason, because it locks in the “win.” Unfortunately, this rather ignores the fact that winners often keep on winning for good fundamental reasons. You know, things such as they're fine companies run by intelligent managers in industries where it's possible to prevent intense competition undercutting margins.

Loss aversion and the disposition effect reveal yet another fundamental human deviation from rationality. Technically, the price we happen to buy a stock at is no more meaningful than any other price the stock ever trades at. Even if we do our research with incredible care and diligence it's a slam dunk certainty that the share price of some of the companies we buy stakes in will decline after we buy them. In fact, I know that the majority of my investments do this (and this isn't an accident or even bad luck, as I'll explain later).

It's an old market mantra that you can never sell at the top or buy at the bottom, and it's one of the rare truisms associated with the markets that's true: you'll never time a trade perfectly other than by chance. So, if the price we buy at is, at some level, a random number, then rationally that price should be no more or less meaningful than any other price. What should matter is the underlying value of the corporation, not the price it's currently trading at.

But, of course, if that were true loss aversion wouldn't occur, because a loss is only ever relative to the buying price. As it turns out this isn't true—humans exhibit yet another effect, known as anchoring, where we attach ourselves to the buying price and assess the success, or failure, of our investment relative to it. In this we're not helped by the prevalence of stock portfolio trackers, which kindly point out our relative successes and failures in graphic and colorful detail.

Anchoring is yet another powerful bias, and it occurs in all sorts of situations. Take real estate for instance, where people will often anchor on the high-water price of a similar property and then refuse to sell for less. This can have major economic impacts, as real estate markets can grind to a halt in the event of a downturn, as everyone refuses to sell, despite the fact that if you sell for less you can usually buy for less.

A similar problem can occur with stocks as well, where people shift their anchors from a buying price to a high-water price. When markets as a whole come off a boom whole swathes of investors may choose to sit on their hands, waiting for the previous highs to be breached before they sell. Unfortunately, market booms are usually associated with a disconnection between price and value, and corrections are about bridging that gap through price reductions—people who have anchored on peak prices in that situation may wait a lifetime to make back their “losses.”

In a beautifully simple experiment that the behavioral economist Dan Airely¹⁶ has used to illustrate the concept of anchoring, simply getting people to write down the last two digits of their Social Security numbers affect the prices they subsequently bid for a range of different items. Roughly speaking, the higher the Social Security number the higher the bid. Yet, if the participants had truly been aware of the real value of the items on offer the arbitrary anchor of the Social Security number couldn't have worked—and this is a critical bit of information, because anchoring causes these problems in situations characterized by uncertainty, where it's difficult to accurately assess the true value of an item. So, this is a situation very similar to that which we might experience in stock markets in times of turbulence, or if we were novice investors, or if we simply weren't very good at valuing stocks or are tired or emotional or … well, the list goes on and on.

Why is anchoring so powerful in these situations? We've already seen the cause of this—it's salience and availability. A buying price, or a peak price, is an easily retrievable and very salient piece of information in an otherwise uncertain world. It's a lot easier to look at a simple number than it is to do the nasty grind of analyzing the true value of a stock. Yet that's the real information we need—does the current share price make the stock a bargain at the current price or not?

Fortunately for us, in a world dominated by biased investors who don't have any understanding of their problems and who are inherently disposed not to seek feedback to solve them, we don't need to have that much of an insight into the issues to give us a vital edge. Stock markets are a zero sum game—if we win someone else loses—so if we have a better idea of what we're doing than the competition we should do okay.

TWO STRANGERS

Applied to money, all of this foregoing behavior should, I hope, seem plainly irrational. We are, in effect, acting in a way designed to destroy our own returns. Economists generally operate on the basis that we won't do this and they have a point, because it's completely idiotic that we don't—ut the fact remains that we don't, and a lot of the problems with the world's economy can be explained by this (along with a marked reluctance to believe economists about most things).

As we discussed earlier, we all have met people who express these general biases to an extreme extent. I'm sure you know someone who is never to blame for anything that goes wrong, yet who is always responsible when things go well. This self-serving bias is most strongly expressed by people who meet success and failure and regard them as complete opposites, rather than simply the normal expression of a normal life.

The research done by Ola Svenson into peoples' attitudes toward their own driving abilities shows the effect in operation when people are faced with a lack of insight into their own driving skills, an area where most of us get fairly regular feedback from other road users, often involving strange hand gestures. In investment we see the same effect replicated; people seem to form strong positive opinions about their investments and then behave accordingly.

For instance, Kent Daniel, David Hirschleifer, and Avanidhar Subrahmanyam¹⁷ have shown that if new information is released that backs up an investor's beliefs then their confidence in their decision grows, but if the information contradicts their beliefs then they tend to ignore it. There's an even more peculiar bias known as the backfire effect, where if you present people with evidence that their beliefs are wrong—that UFOs aren't real, that President Obama isn't an alien, or that Elvis is alive and well and selling yakburgers in Outer Mongolia—then they become even more convinced that they're right. Somehow, it's not the information that's relevant but the reinforcing effect of discussing it that seems to trigger the bias.

It was Rudyard Kipling who said that we should meet triumph and disaster and treat them the same, but mostly we can't. If you trace the path of our bias for feelings of positive self-worth through the introspection illusion and the blind spot bias to overconfidence, and from overconfidence to the disposition effect and anchoring, you'll find a clear case for finding that self-serving bias is critical to our notions of self-esteem. Unfortunately, our self-esteem is often wrapped up with our beliefs about our investing skills, and so behavior that is fine in everyday life may be something we need to put behind us when we turn to handling money and investing, if we want to achieve the best returns.

Oddly, we don't always want the best returns from our investing activities, but that's another story. For now, let's focus on another odd feature of this array of peculiar behaviors—just like drivers we constantly get feedback that should show us whether we're doing stupid things or not. So why don't we learn from it?

HINDSIGHT'S NOT SO WONDERFUL

Why don't we seem to learn from the lessons of the past? After all, if we keep on making mistakes based on the type of behavioral biases discussed here you'd think that eventually we'd notice that we're not particularly good at investing. The large hole in our bank accounts might be a giveaway, you'd think. Unfortunately, there's another bias at play, one that the CIA describes as ineradicable—hindsight bias.

Hindsight bias is the peculiar finding that we think we predicted the present in the past, when in fact we did no such thing, because what we actually do is modify our memories to make us think that way. It appears that we're utterly unable to divorce the actual experience of the present from our memories of what we thought was going to happen: the present colors our perception of history. What's even worse is that the past is, at best, a very imperfect guide to the future.

One of the world's experts on judgement and decision making, Baruch Fischhoff,¹⁸ has performed a raft of interesting research around the topic of hindsight and has shown that people are largely unaware that their perceptions are changed by becoming aware of actual results—or, to put it more simply, our memories of what we predicted are biased by the knowledge of what actually happened. He also points out that knowing that this happens doesn't offer us any way of fixing the problem, which is why the CIA has such a problem, because they can't rely on even the best trained agents to give a true picture of prior events. It's not that they're lying, it's that they can't help interpreting events in the context of eventual outcomes.

This matters for the simple reason that if we project this issue forward it means that we're generally rather confident—overconfident in fact—about our ability to predict the future. After all, we successfully predicted the present so why should the future be any different? Only we didn't predict the present, we simply misremember this. The net result is, of course, overconfidence, and that overconfidence is the killer for our investment returns.

Goetzmann and Peles¹⁹ conducted some research on investor recollection of their returns against actual performance. For reasons that escape me, their first group of subjects were architects, a profession not especially known for its investment expertise—although perhaps that was the point. Anyway, the research showed that in between designing carbuncles and flatpack housing they recalled a performance that was over 6 percent higher than it actually was. Looking at people who thought they were actual investors produced a slightly better result—they only overestimated by over 5 percent.

As Fischoff suggests, we simply cannot remember the past accurately—our memory systems aren't built for that purpose, but rather are designed to help us adapt to future challenges. Unsurprisingly then, hindsight bias is another issue that experience doesn't help resolve. But while this type of problem is something we can't eliminate we can drive ourselves closer to a safer approach to investing, by continually attempting to reconstruct our past decision making processes in order to put in place systems to manage and reduce our errors.

This is another reason for keeping a diary of when and why we made trading decisions, what the outcomes were, and why those outcomes were achieved. It's absolutely critical to our investment management, as we attempt to drive ourselves towards behaviors that err on the side of caution. We can't improve without constantly exposing ourselves to the results of our own mistakes, no matter how little we like the experience.

DEFERRAL TO AUTHORITY

Oddly, all of this manipulation of our own self-image to make us feel good about ourselves exposes us to being gamed by charlatans. As Milgram's experiment showed, we're scarily inclined to defer to authority figures. Milgram's white coated researchers were fakes, and as Alfred Cowles demonstrated, the investment world is full of experts with an equivalent level of knowledge and skill. Yet these experts are just as unhinged by behaviorally induced overconfidence as the rest of us.

The foremost research on the inability of experts to actually predict anything very well has been done by Philip Tetlock,²⁰ mainly in the study of political forecasts—although there's no reason to presume that his findings don't apply to the world of investment as well. To simplify a vast body of research, he found that most experts were slightly worse at forecasting results than the average man in the street, yet were profoundly unwilling to accept the fact—more evidence for blind-spot bias—with a whole heap of hindsight bias and overconfidence thrown in, alongside yet more examples of the conjunction fallacy.

In general, experts come up with one of three excuses. Firstly, there's the “I was right but it just hasn't happened yet” get-out clause. So that stock market crash is still just around the corner, and if you keep on forecasting it forever, you'll eventually be right. Many investment pundits have made a career out of this technique.

The second excuse is the “I was right but for something that happened that couldn't have been predicted.” This, of course, ignores the fact that most events are contingent on other events and that life is essentially unpredictable. And if you don't accept that in real life there's plenty of evidence to show that it's true in stock markets.

Finally, experts come up with the “I wasn't wrong” excuse. This works a surprisingly large amount of the time. In fact, it turns out that most people don't actually analyze the track records of so-called experts but simply take their word regarding their expertise. Joseph Radzevick and Don Moore²¹ investigated this finding and uncovered the scary fact that the pundits we prefer are not the ones that are most accurate but the ones that express the most confidence that they're right. Sadly, the ones we should trust are sometimes the less bullish, less confident, more diffident ones who at least recognize that the world is simply too complex to predict with any certainty.

So it shouldn't be a surprise that it's not just overconfidence that's the hallmark of the convincing but inept expert. It turns out to be a particular kind of overconfidence known as over precision: “an excessive certainty about the accuracy of one's beliefs.”²²

The best pundits, and the worst forecasters, come up with extremely detailed and convincing arguments about what's going to happen and why, most of which never come true. They are as much victims of the introspection illusion as we all are but the gullibility of their public means they never need to improve.

EMOTION

By now it should be fairly obvious to you that we're not really very rational when it comes to money. In fact, most of the time we're downright emotional about it. And emotions are central to our money management issues. One fascinating series of experiments, by psychologist Antonio Damasio,²³ was centered around people who have suffered a type of brain damage and don't feel emotions the way that most people do.

It ought to be reasonably clear that we have emotions for good reasons. If we drive around a sharp bend too quickly we get a quick shot of fear and next time we're more likely to take it easy. But someone who doesn't experience emotions isn't likely to learn that lesson. However, what in the real world may open us to danger is actually advantageous when it comes to investing, because in investing we need to learn to play the odds in a world that is essentially full of ambiguity and uncertainty.

So, where uninjured people will get all emotional over a loss or a gain and demonstrate the behavioral effects we've already discussed—loss aversion, the disposition effect, and so on—the brain damaged individuals will keep on investing based on what appears to be a rational calculation of the odds. They're simply not swayed by the kinds of emotional considerations that most of us take for granted.

Which leads, you'd think, to the conclusion that unemotional investing is best, and also to the immediate problem of what we should do about it. After all, emotions are hard-wired into us for good reason. Well, as it turns out, it's a bit more complicated than you might expect.

In a famous experiment by Damasio known as the Iowa Gambling Task,²⁴ the researchers produced four decks of cards, two of which would consistently produce losses and two of which would consistently produce gains. What's interesting is that the way that the losses and gains are generated are different: so one of the losing decks consists of lots of losses while the other one consists of lots of gains and one whopping great big loss.

The history of the experiment is long and tortuous, but roughly it turns out that brain damaged participants never learn to avoid the losing decks, while the uninjured participants do—and they do so surprisingly quickly. Although it takes them 50 card choices before they can consciously report a problem with the bad decks they actually start to preferentially avoid them after only 10. Somehow, emotion and logic are integrated to allow us to sense danger.

This, unfortunately, is exactly the wrong thing to do in the stock market, where a trend is probably simple random noise, and tends to ignore the problem of Black Swans, otherwise known as disaster myopia.

BLACK SWANS

Nassim Nicholas Talib is rightly famous for his trenchant views about, well, almost everything. He's often very rude about investment managers, and other members of the financial community, and he often has a point. Perhaps the phrase most associated with him is that of the Black Swan—the idea that sudden, unexpected events can overturn our expectations.²⁵ All swans are white, until one day we meet a black one. This bolt from the blue overturns all of our expectations—and, really, just shows us that all of our expectations about the world are provisional: Black Swans are unpredictable and have huge consequences. The ground is solid until you experience an earthquake and markets can only go up until they collapse.

Well, there's a similar bias in human behavior. Typically we're myopic—short-sighted—about the world for the reasons we discussed in the previous chapter—it's a form of observer bias, where we draw wide ranging conclusions about the world from our small sample of personal experience—and it's a form of hindsight bias, where we misinterpret our own history. In particular, we are very disinclined to see the world as random, and desperately try to make order out of chaos. As humanity's success shows this isn't a bad model, and it works most of the time. However, occasionally disaster strikes and our models, and our lives, are overturned.

When some Taiwanese researchers re-analyzed the results of the Iowa Gambling Task they noticed something strange that was hidden by the original experiment design.²⁶ Although it was correct that undamaged individuals did appreciate the risks inherent in the bad deck, where there were lots of poor results, it turns out that the most popular deck was the other bad one, the one in which there were lots of good outcomes and one hugely bad one. As Talib would be quick to point out, this is pretty much analogous to the way that stock markets work—mostly they chug along, moving gently upwards until one day the whole thing blows up. There's a natty little phrase for this: “picking pennies up in front of the steamroller.” It's a great way of making money until you slip over.

That we're attracted to situations which give us lots of positive feedback, even if we're only making very small amounts of money, isn't surprising. We like to win, to make profits, and we don't like losing. Yet many of the great investors seem to do the opposite—they lose more often than they win, but they cut their losses quickly and they run their winners so that when they win they win big. It's been described as the Babe Ruth effect, after the great baseball hitter, because he struck out often but when he connected he hit a lot of home runs.

Our failure to recognize that a disaster is always possible is a bit more puzzling, but is associated with an issue known as disaster myopia. It seems that we're very quickly able to adjust to the new reality after a disaster, and as time goes on we rapidly discount the possibility of one happening again. And, of course, the more we discount the possibility the more likely a problem is to occur.

DIRTY MONEY, MENTAL ACCOUNTING

It's impossible to disentangle the effects of emotion from the way we treat money. Here's an example. Jonathan Levav and Peter McGraw²⁷ showed that people associate money with emotional tags that are dependent on how they earned it. This so-called moral accounting means that money that people have earned by less than honest means tends to be laundered by purchasing virtuous stuff, like education, rather than on hedonistic pleasures, like alcohol or tobacco.

This is a form of mental accounting, where people assign money to different mental pots and then treat them separately. Mental accounting is a very odd thing, but we all do it. People “put aside” money for a rainy day, keep special accounts for holiday savings, and generally segregate their capital for different reasons. All of which is done for good reasons of self-control, in order to make sure that the future is paid for. Unfortunately, a virtuous behavior in normal life turns into a malicious one in investing.

Remember the idea of loss aversion, where we seek to avoid taking a loss if at all possible? Well, if you add mental accounting to this mix you suddenly find that people are able to segregate different parts of their capital and manage their profit and loss on each account separately. This can have pernicious consequences—how often have you heard about someone who sells half their stock when it doubles because they're now in the stock for free? This is rubbish, of course, because what matters is the total amount money, not the loss or profit on a single share.

People will take advantage of mental accounting to shift loss-making stocks about and to aggregate them with others, in order to minimize their feelings of regret. Regret is a yet another nasty bias, because we tend to regret actions we have taken more than ones we didn't—sins of commission matter more than sins of omission—and we often get tangled up with our feelings about past decisions. In some further Barber and Odean research, along with Michal Strahilevtz,²⁸ they showed that people buy backs stocks they previously sold for a profit, but not ones they sold at a loss, but only if they've fallen in value.

Fiddling about with our mental accounts is a particularly effective way of indulging our preferences for avoiding losses in order to reduce any feelings of regret we have. This leaves us feeling happier, but is utterly hopeless behavior when it comes to maximizing our returns.

A FAINT WHISPER OF EMOTION

Of course, “feeling happier” is exactly the point; it's all about our emotional responses to financial transactions. All of this odd fiddling around with money is intimately connected with the way we regard ourselves and the emotions that failure or success generates. In theory, when it comes to investing whether or not we're successful should be an easy thing to assess—it's all in the numbers, after all. But even if we do measure these correctly, which we're inclined not to do, we still have a lot of ways of avoiding taking responsibility for our actions. Many of these are downright peculiar when we analyze them logically, but make perfect sense to anyone who spends their days studying how humans actually handle themselves in situations governed by risk and uncertainty—which is pretty much any situation you care to mention when it comes to stock market investing.

What psychologists have found is that we definitely don't rationally assess the risk and reward of any given situation but rather rely on a sense of goodness or badness in any given situation. Just as people will morally account and tag money as tainted under certain circumstances, we tag everyday events in the same way. This emotional tagging is often described as a “faint whisper of emotion” but is more accurately known as “affect.” The affect heuristic is yet another one of those loose rules that we use to guide us through our lives, lying virtually unconscious below the surface of our minds, and is consciously accessible only with real effort.

While the affect heuristic is a darn useful technique for managing risk in everyday life it's certainly not without its problems. For instance, if we like something we judge it as less risky and if we don't like it we judge it as more. So, for example, take an example we've already seen, the fact that most people judge nuclear power as riskier than X-ray machines when the reverse is probably true. Exactly the same sort of behavior is seen with investors, both private and professional.

So when Yoav Ganzach²⁹ looked at how professional securities analysts judged the risk-return opportunity of specific stocks he found that where the experts already knew the corporations in question then the actual risk and expected returns were correlated, but when they didn't they fell back on global attitudes rather than relying on their own. This looks like the affect heuristic in operation, rather than some careful assessment of real risk and reward. And one result of this is that stock market sectors with a buzz about them get rated more highly than those with bad karma—and this has nothing to do with real valuation, but is solely based on that whispering emoting voice at the back of our heads.

There's a correlate to this: sectors associated with bad news often outperform over three- and five-year periods. This is just the action of the invisible hand, as unreasonably depressed valuations are picked up by astute value hunting investors.

PSYCHOLOGICALLY NUMBED

The affect heuristic seems to have another impact on us as well, something that Paul Slovic³⁰, who has led much of the research into risk perception, refers to as “psychophysical numbing.” Remember that we're highly sensitive to personal observation in preference to statistical analysis of broad trends for the good reason that this is the environment we evolved in. You would expect people to respond to their own experiences rather than those of other people, even if their own experiences are atypical. Overcoming this is difficult.

Slovic goes beyond this and suggests that we're actually biased against the type of statistical analysis that is most beneficial to us as investors, and suggests that this is a side effect of the affect heuristic. He thinks that the affective system is designed to make us acutely sensitive to small changes in our local environment, but at the cost of making us insensitive to big changes. In essence, we can respond to anecdotes and stories because we can understand personal risks and empathize with the participants but we simply can't grasp the vastness of some of the numbers that modern life throws at us.

This isn't just about investing, of course. At the end of the twentieth century the United Kingdom found itself in the grip of a panic about the affect of the so-called triple jab—a single vaccination against measles, mumps, and rubella. An article published in The Lancet purported to find a link between the triple jab and the rise of autism in children. It was clear almost from the beginning that the risks associated with not having the jab were greater than the risks of having it, even if the research was correct, but it was also clear that there were grave concerns about the research itself, which was eventually thoroughly discredited.

The result, of course, was thoroughly predictable. Faced with scary anecdotes of autistic children versus statistical evidence of a lack of a real correlation people abandoned the vaccination program in droves, driving down the level of vaccinations for that particular cohort of children to the point where group immunity was compromised. The consequence was inevitable, and has led to a rise in measles cases across the UK. Now, faced with more media-driven anecdotes of children suffering and potentially dying from a lack of immunity, parents are flocking to fix the problem. Stories are powerful, statistics are not.

In general, we need to be wary of anecdotal evidence. Statistics strip away the emotional whispers we like to rely on, and that's often a good thing in life. In investing it's essential.

MARTHA STEWART'S BIASES

For a real-world example of the problems that unsuspecting investors can run into with their biases we need look no further than celebrity chef, and one-time penitentiary inmate, Martha Stewart. During her trial for insider trading her portfolio was published as part of the evidence and this allowed Meir Statman³¹ to analyze it for behavioral bias. What he discovered is probably pretty typical of most private investor portfolios.

Ms. Stewart demonstrated loss aversion, through her unwillingness to sell stocks at a loss, and regret, because she was also unwilling to sell them at a profit—what would she feel like if the stock went up a lot the following day? She also demonstrated a peculiarly American bias, the December effect, where she was willing to sell stocks at a loss in December, but only to mitigate taxes before the end of the tax year, a clear case of mental accounting and a rare one where it's influenced by actual accounting.

She also showed a tendency to scapegoat her advisers—if the stock goes up it was the investor's decision, but if it goes down the adviser got it wrong: the fundamental attribution error, and evidence for the disposition effect. These biases are not fictions, and they have real effects on ordinary investors' personal wealth and life prospects. Advisers can perform their clients a real and ongoing service by educating them about these facts.

All of this odd, interconnected behavior is ultimately linked back to emotions and the way we regard ourselves. The obvious counter to this is to be more aware of why we're doing things, to ensure we're mindful in the face of all of the things that can cause our biases to trigger and lead us into temptation, and losses, and sometimes worse.

Mindfulness, and its opposite, mindlessness, is a subject Ellen Langer has studied carefully over a long period of time. This work comes out of her illusion of control problems we looked at in the previous chapter, and draws on the idea that we need to pay conscious attention to what we're doing in order to obtain the best possible outcomes. Unfortunately, paying this kind of attention to anything, let alone something as confusing as money, seems to actively deplete our mental resources: as Kathleen Vohs and colleagues³² have shown, the more decisions we make the more likely we are to impair our self-control.

It's clear from most of the evidence in this chapter that our emotions, especially around our feelings of self-esteem, can drive us into some particularly poor decision making. Paying active and careful attention, in light of the knowledge of how we're biased, ought to improve this. However, the issue of resource depletion means that even with this level of self-knowledge we still really need to try and minimize the number of decisions we make, which, as Barber and Odean would observe, should lead to immediately better outcomes, for Martha Stewart and us all.

RETROSPECTIVE

Let's pause briefly and look at the ground covered in this chapter. We can trace a set of fundamental problems from our over-reliance on the introspection illusion. Because we're fundamentally biased towards a positive self-image, we're led into overconfidence. The same bias means we don't like facing up to evidence that we're wrong, which prevents us from adjusting our overconfident behavior. Our overconfidence leads us into overtrading and our failure to elicit feedback, which can damage our self-image; this means we preferentially sell successful investments, to lock in winners, and keep unsuccessful ones, to avoid taking losses—the disposition effect, which is an outcome of loss aversion. Loss aversion is conditioned by anchoring, and anchoring is an outcome of the more fundamental biases of salience and availability.

We also tend to defer to authority figures, such as investment experts and tipsters, particularly ones that specialize in overconfident and overly precise forecasts. Unfortunately, these people are generally no better than average at making such calls, are usually just as biased as the rest of us, but are heavily incentivized to avoid facing up to this—after all, if your career depends on being regarded as an expert you're not likely to go around admitting you're no such thing.

All of this is linked by the underlying, ever present whisper of emotion, our reliance on the affect heuristic in order to judge whether things are safe or not. And, as so often happens, this doesn't work in the stylized and complex environment of the stock market. So what can we do about this, what measures are available to us to protect ourselves from our lack of self-knowledge?

Even though it's a nasty minefield of self-deception, we're not completely defenseless in the face of our own egos. With a bit of conscious effort we can overcome many of these issues, and the ones we can't face head on we can avoid, if we know what we're doing.

ANNUAL RETURNS

Exactly how the disposition effect and overconfidence interact, as witnessed by overtrading, loss aversion, and anchoring, is hard to say. In fact, this is one of the weaknesses of behavioral finance because we still don't understand how the various biases interact, but it's still perfectly clear that these behaviors tend, on average, to drag down our investment returns. One possible reaction to this is to avoid inspecting our portfolios on a regular basis, because the more notice we take of what our stocks and investments are doing on a short-term basis the more likely we are to be panicked or otherwise persuaded into trading. The question then, of course, is how often we should take a peek at how our money is managing by itself.

The answer turns out to be not more than once a year. This unexpected finding was the result of research by Werner de Bondt and Richard Thaler and is, unsurprisingly, known as the de Bondt-Thaler hypothesis. Their empirical data suggested, just as the evidence above indicates, that the more often investors inspect their portfolios the more often they trade and the appropriate response to this, they argue, is to avoid the problem entirely.

The idea of self-control by abstinence is one that reoccurs throughout the research on behavioral finance; there's a persuasive line of thought that many of these underlying biases are simply so strong that most of us will be unable to overcome them by active means so we need to practice the investing equivalent of chastity. It's a miserable thought, but if our self-image is so strongly bound up in our relationship with money then, for many people, it may be the only way. We can trace the rise of passive index tracking funds that essentially take asset allocation control out of the hands of individual investors or fund managers to the recognition of this situation.

NUDGED

Richard Thaler, along with Carl Sunstein, has taken this idea a step further into the realm of so-called “nudge theory.” The concept has been used in a wide variety of situations, but most famously in retirement savings. One of the big issues facing the Western world, with its aging populations, is that most of us don't save enough for our retirement years. Part of the problem is that we have to constantly make decisions about investing for our futures and, it turns out, we're actually not very good at delaying gratification and spending less now in order to have a more comfortable life later on.

Thaler and Sunstein³³ have come up with a Save More Tomorrow™ scheme, which means that savers only need to make one decision and the rest happens automatically—the amount they save automatically increases as the amount they earn goes up. This relies on people actually tending to fail to make difficult decisions and defaulting to the standard option—in this case the default option selected is to save more and most people never change this.

Default options are now being used in a wide variety of situations in order to coax people into doing what's best for them, from health care through to social policy, but they may well be most effective when used in financial situations, which seem to bring out the worst in us. Coming up with sets of rules and following them rigidly is one way of using the theory, but it takes a very strong-minded person to stick to such an approach when things go wrong; but the beauty of such methods is that they remove our issues of self-worth and self-esteem from the investment equation because if we don't take a personal interest in the stocks we invest in then we don't invest ourselves in them.

MINDFULNESS

The idea that we should be consciously aware of our own biases and pay attention to how they affect our investing is easy enough to state, but a lot harder to do. We have the problem of resource depletion—paying attention to things saps our ability to keep on paying attention—and have the issue of deciding what we want to focus on. There are so many things going on when we invest that it can be hard to decide what to pay attention to—which is one reason why a rules based checklist is a good thing to have.

Catherine Weick and colleagues³⁴ came up with an interesting variation on this theme when they took a look at the problems of mindlessness in safety critical organizations—like nuclear power stations. Their checklist is a very useful starting point for logical investors:

• Be preoccupied with failure.
• Do not simplify interpretations.
• Be sensitive to odd events.
• Be resilient.
• Don't get too clever.

So, before we end this chapter, let's take a brief look at each of these in turn.

Be Preoccupied with Failure

An overt concern for getting things wrong, and a furious determination to get them right in the future is the hallmark of a safety first investor. In fact, because stock markets are far less predictable than, say, nuclear power stations, this is harder to do than you might think, but there are some quick wins.

Firstly, you have to identify your failures. There's no point engaging in mental accounting in order to spare your ego the humiliation of recognizing that you've got things wrong again. It's necessary to aggregate your accounts and carefully track your profits and losses.

Secondly, you need to analyze the data properly. What went wrong and why? Is this failure absolute—perhaps you made a mistake—or is it relative—maybe the market went up 200 percent while you only made 50 percent? It's easy to be pleased with a gain, but when it's a lot worse than the return on an index tracker then you're fooling yourself.

Finally, codify your actions: turn them into actionable rules that you can build into a checklist or some other form of guidance. Don't just assume you will remember what went wrong when you go investing again—hindsight bias will guarantee that you can't.

Do Not Simplify Interpretations

It's terribly easy to lapse into simple default behaviors, to do this time what you did last without thinking about it—the very definition of mindlessness. “Buying on the dips” worked right up until it didn't, but brainless investors carried on with this approach while the markets kept on falling. A checklist is a good starting point but it needs to be continually reviewed in the light of reality.

Moreover, the decision making processes that sit behind what stocks we choose and when we choose to buy and sell them are not straightforward either. You will be amazed by the reasons we find for buying and selling shares. For instance, we will often buy back a stock that has fallen from our selling price but we won't if it has risen. And we positively hate buying stocks we sold at a loss when they've risen, regardless of the circumstances. We don't like being reminded of our tendency to regret things.

Availability and salience figure highly amongst the issues we face in stock selection. Yet they're awful ways of choosing stocks, which don't care about whether their brands are well known, their CEOs are in the news a lot, or our best friend tipped them. Understanding why we choose the shares we do, and why we choose when to buy and sell is essential, otherwise we'll all end up like Martha Stewart. Only not in jail, hopefully.

Be Sensitive to Odd Events

There's nothing quite like an exception to a rule for improving our models. We will tend to ignore such exceptions, because we prefer to ignore data that contradicts our prior opinions in favor of that which supports them. However, exceptions are interesting because the investing environment is ever fluid and changing. We regularly see market behavior change, and we should be on the outlook for such signs.

Learning to pay attention and to appreciate odd events is far harder than you might think, but yields invaluable lessons. Investors who happen to learn to invest in one particular type of market—the long bull market of the 1980s and 1990s, for instance—are apt to believe that the market behavior they experience is fixed and unchanging. They're wrong, as we saw when these markets faded into the bear market at the start of the twenty-first century.

It's important to recognize that not even the big picture remains constant. If we build our models and tools purely based on our own experiences, even of the wider world, we'll still have a problem when that world changes again.

Be Resilient

Things go wrong when we go investing. As we've seen, we often contribute marvelously to these things going wrong but it's important not to get overly fixated on this. All too often things will go wrong that we have little control over. In 2005, investors in the UK Internet retailer ASOS woke up to discover that its main warehouse had just gone up in flames because a nearby oil storage facility had exploded. Obviously this is the type of thing that can happen when you hang out around petrochemical plants, but investors could have been forgiven for not factoring this into their analyses.

A lot of stuff in markets is simply random, and we can't get every decision right, all of the time. It's important that we analyze what we do, and draw the appropriate lessons, but it's equally important that we stay resilient in the face of disaster. Sometimes we make good decisions and things still go wrong; that's the nature of very complicated environments like stock markets. Unfortunately, we're programmed to learn to avoid things which give us nasty negative shocks, but this is not the way of the logical investor.

Don't Get Too Clever

Yes, it's very, very easy to over-complicate things and come up with huge lists of variables, which you can feed into computers for them to churn out results. This is, more or less, how we ended up with the subprime crash in 2008, when the risk managers convinced themselves that they could model the real risk of lending mortgages to people whose only asset was a tin bath and a sink.

In fact, too much data leads to a problem known as information overload, where our limited brains start to fizzle and fuse under the pressure of data. And, unsurprisingly, our ability to process it accurately also declines. So we really need to spend time simplifying our processes and our thinking—it's simply not enough to add more and more data points to our analysis tools, unless we can turn this data into information that we can use. And, as we'll see, this is definitely an approach worth considering.

THE SEVEN KEY TAKEAWAYS

This chapter has introduced our personal feelings in the investing equation, and shows that a natural bias in favor of ourselves—the so-called introspection illusion—can lead to a whole range of poor investing behaviors. These problems occur in everyone, not just private investors: so-called experts are just as prone to them as you and I, so you need to choose your advisers with care.

To finish, let's draw together a few key ideas from this chapter before we move on. The main takeaways are:

1. Most of us think that we're better than average at things that matter to us, so if we care about investing we're quite likely to be exaggerating our abilities: this, at least, should be our key starting assumption. So there is a definite bias in favor of overoptimism, and overoptimism leads us into overtrading, and overtrading forces us to make more decisions and, the evidence shows, we're more likely to make mistakes.
2. Overconfidence leads to loss aversion and the disposition effect, where we sell our winners and keep our losers in order to avoid taking a loss; this is silly behavior given that all too often losers go on losing and winners go on winning.
3. Many experts are no better than average at making predictions, but we're attracted to confident individuals, a feature known as deferral to authority, and, as usual, we ignore the data—make sure you can test your expert's abilities.
4. Some biases, such as hindsight bias, cannot be entirely removed but they can be managed; however, experience does not solve all problems, and it's better to learn from other peoples' mistakes than from your own.
5. We're myopic about past disasters, preferring to relegate them to the sock drawer of forgetfulness, but we shouldn't. Never forget that a disaster is just around the corner and that it's brightest just before the sun goes out.
6. Our decision making is driven, for very good reason, by emotion. Being coldly emotionless about our investments is the best possible state, but is never entirely achievable. However, adopting a carefully mindful state about our decisions is helpful and if we're too tired to be mindful we should go and do something else.
7. Even if we do everything right sometimes stuff just happens. Accept this and move on—emotional resilience is critical for all good investors.

I hope it's becoming clear that many of the biases that unconsciously influence our investing decisions are actually quite healthy in a normal human being. So making mistakes is perfectly natural—it's just that we really don't want to go on making them!

Now we're going to look at what happens when the outside world starts to take an interest in us as advisers. Thus far, we've focused on disposition; now we're going to take a more detailed look at situation.

NOTES

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