This article is the second part of a two-part series on aspects of behavioural biasness that are important in our daily lives as a value investor. If you have not looked at the first article, I strongly encourage you to do so before reading on.
To summarise, the following are the three aspects we have shared with you in the first article:
- Power of incentives
- Consistency and Commitment
Why is having a basic awareness of behavioural biasness so important?
Having the knowledge equips us with the tools to make better decisions. Being conscious of the common psychological pitfalls that we may encounter better prepares us when such situations arise.
Without further ado, we will be introducing three more key points that we believe should be duly noted by all value investors!
Bias from reciprocation
The idea is very simple. When an individual does something for you, you will experience a nagging discomfort if you do not reciprocate as soon as possible. We do not like to owe others any favors and would alleviate this uneasiness in any possible way possible.
Research has shown that when a stranger does a small favor for you, the next time he needs help, regardless of how ridiculous it is, chances are that you will find yourself helping him.
The following excerpt from Influence by Dr Robert Cialdini shows how “free sample” is actually a brilliant way of monetizing the reciprocity rule.
One of the best examples that most of us can relate to would be HaiDiLao’s business model. It is build upon this concept of reciprocation, offering free food, drinks and manicure services, while you wait in line for hours.
With this in mind, you can view macroeconomic events and politics from a clearer lens. The hidden agenda being exposed will bring truths about organisations and help you to make better investment decisions.
Like reciprocity, the influence of social proof is another powerful factor in determining your daily actions.
As shared by Charlie Munger, tens of people stood by and did nothing while Kitty Genovese was murdered before their eyes. When questioned, they made excuses such as “I thought the others would call the police”, “Oh, I don’t know. I was scared” or “I didn’t want to be involved”.
All these, of course, are nonsensical reasons to justify the failure to prevent a murder.
What could’ve gone through their minds?
Research has shown that when we are grouped up with others, we have a strong tendency to follow the crowd. When everyone else was not doing anything while the poor soul was murdered, everyone thought it was the “right” thing to do then. Everyone seek social validation.
The next time the media tells you that the market is crashing and all the large institutional investors are selling, you know what you shouldn’t be doing!
Bias from anchoring
Anchoring is a cognitive bias that describes the tendency for an individual to rely too heavily on an initial piece of information offered when making decisions. Even though this may have little or nothing to do with the situation at hand.
You have perhaps heard of recency bias. Experiences that you have experienced a while ago has a greater impact on your decisions. If by coincidence you started having good fortune after you changed your bed sheets, you may attribute such occurrences to the usage of new bed sheets…and this is how some people are more superstitious than others!
We shall now explore what may be going through your minds when you go shopping.
When you first enter a store, your eyes will most likely gravitate towards the “SALE!” signboards. Next, you will be looking out for the degree of discount given. In your head, you will probably be doing some quick calculations about how much you will be saving based on the information readily available in front of you. By doing this, you have already taken the bait by using the stated original price as the anchor to make your shopping decisions.
Shoppers love it when the shops do the calculation for them and most are willing to trust the stated prices wholeheartedly, but should you really?
When you are about to sell your stock because of good sound reasons and the market suddenly heads south, maybe by a “devastating” 5% from before. While the new price is still within your target valuation range to sell at, you may experience some psychological discomfort. In your mind, the one price before the correction has overridden all valuation and judgement you have made.
Now that you are aware of this phenomenon, you no longer have any excuses! Sell when it’s time to sell and buy when it’s time to buy. Don’t be influenced by superficial influences.
Protect yourself from such influences
By being aware of these psychological dangers, you have already gained the first defense against them. Most people who aren’t aware are suppressed by these influences every day. Even the brightest person will not make smart decisions if they are on the receiving end of these tools.
The next step you have to take is to analyze your weaknesses and know when you are prone to stumble. Draft out a game plan in your mind so that you don’t have to think but to just follow instructions when any such situations arise.
Slowly but surely, by understanding such behavioural biasness, you will gain a great control over the decisions you make and the life you deserve.