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Today I discuss three psychological tendencies that can lead investors astray.
Cognitive dissonance
If a belief has been held for a long time people continue to hold it even when such a belief is plainly contradicted by the evidence. People experience mental conflict when presented with evidence that their beliefs or assumptions are wrong, resulting in denial for a considerable period.
Charlie Munger put it this way in a Harvard University speech in 1995:
“Well what I’m saying here is that the human mind is a lot like the human egg, and the human egg has a shut-off device. When one sperm gets in, it shuts down so the next one can’t get in. The human mind has a big tendency of the same sort.
And here again, it doesn’t just catch ordinary mortals; it catches the deans of physics. According to Max Planck, the really innovative, important new physics was never really accepted by the old guard.
Instead a new guard came along that was less brain-blocked by its previous conclusions.
And if Max Planck’s crowd had this consistency and commitment tendency that kept their old conclusions intact in spite of disconfirming evidence, you can imagine what the crowd that you and I are part of behaves like.”
Investors must reduce cognitive dissonance tendency by being more open to changing minds when presented with evidence.
Two examples:
Airlines
For decades Buffett and Munger held that the airline industry had very poor economics; so bad that since Orville got off the ground the cumulative profits of all airlines amounted up to less than zero.
But, in more recent years Berkshire Hathaway has been buying into US airlines. Why?
Because the economics of the industry has completely changed, with much more market power accorded to the leading players. The facts changed.
Newspapers
Two changes of mind here. In the 1970s and 1980s newspapers were seen as great businesses especially in one-paper towns. BH bought newspapers and held for many years.
Then the internet took away much of their advertising and readers – the economic franchises were generally greatly weakened. Warren and Charlie took a more pessimistic view and didn’t want to hold newspaper shares.
In the last decade a more nuanced attitude has developed with some small town local papers being seen as strong franchises
(BTW: this probably had nothing to do with it, but for the record, ten years ago I wrote to Charlie Munger to say I thought they were right to be pessimistic about national paper but not correct to be pessimistic about all one-paper towns – he probably didn’t even read it and came to his own conclusions)
Availability bias
People may focus excessively on a pa…
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