It’s vital that we value investors continue to develop our rationality muscles. This requires both good habits and a willingness to regularly review our thinking. Charlie Munger advises “continually challenge and willingly amend your “best-loved ideas””.
An important input to that process is to identify and reconcile disconfirming evidence. If you are approaching a “conclusion” regarding say the intrinsic value of a company then take time to actively search out information that might contradict that conclusion.
This discipline will result in little alteration to your view most of the time, but occasionally the new evidence will blow your idea out of the water, and means you avoid a dreadful error.
This hard to do task helps us avoid the common problem of “first conclusion bias” in which we hold tenaciously to a prior belief despite the obvious presence of contradictory evidence.
Indeed psychological studies have shown that many people have a tendency to hold an erroneous idea even more closely as they are presented with more and more disproving evidence (need I mention “The Steal” of Trump’s presidency or the economic benefits of Brexit?)
John Maynard Keynes, the famous economist and investor was all in favour of challenging one’s ideas but said it’s not easy “the difficulty lies not in the new ideas but escaping from the old ones”.
But, despite the diffulty “if you don’t see the world the way it is, it’s like judging something through a distorted lens” (Charlie Munger), so the work has to be done.
Rationality and objectivity are so prized by value investors that they place this virtue head and shoulders above intellect or knowledge. Benjamin Graham observed this 100 years ago:
“The investor’s chief problem - and even his worst enemy - is likely to be himself....We have seen much more money made and kept by ‘ordinary people’ who were temperamentally well suited for the investment process than by those who lacked this quality, even though they had extensive knowledge of finance, accounting and stock market lore”
Rationality is something that can be developed if you have the determination to improve: “If you don’t care whether you are rational or not, you won’t work on it. Then you will stay irrational and get lousy results.” (Charlie Munger)
Prof Glen Arnold now offers a Managed Portfolio Service at Henry Spain Investment Services under which clients’ portfolios contain the same shares as his (write to Jackie.Tran@henryspain.co.uk)
I'm a full-time investor running my portfolio. I invest other people's money into the same shares I hold under the Managed Portfolio Service at Henry Spain. Each of my client's individual accounts is invested in roughly the same proportions as my "Model Portfolio" for which we charge 1.2% + VAT per year. If you would like to join us contact Jackie.Tran@henryspain.co.uk
investing is about making the right decisions, not many decisions.