Things investors should hate 4/5: Observation

2nd August 2012

No human being can resist trying to draw general conclusions from personal observation.  It's not purely a matter of wilful ignorance, but is an in-built evolutionary trait necessary for our ancestors' survival. After all, on the primeval savannah if you didn't learn rapidly from experience you were likely to end up as a lion's dinner.

Unfortunately, in our globalized, modern investment world personal observation is about as useful a survival trait as poking a sleeping cobra with your bare foot.  It's just that the poison is a lot slower acting.

Quite clearly learning from personal observation is an incredibly important behavioral feature for humans.  If we didn't quickly figure out that the cars drive on the wrong side of the road in Hong Kong, or that Scandinavian women tend to stand surprisingly close to people they're talking to without having the slightest personal interest in them, we'd rapidly find ourselves in a great deal of trouble.  However, these observations tend to be located close together in terms of time and space, and they're not always generally applicable.

For example, in the late Middle Ages, in Sweden, the rulers developed a local belief that they were a great nation.  This was largely based on their residence in the capital city, which was indeed busy.  However, when they carried out the first-ever population census it turned out their actual population was a factor of ten lower than they thought.  Thus evidentially armed, Sweden stopped invading other countries and concentrated on developing a new line in knitted pullovers.  Thus making the world a safer, and warmer, place.

The concentration on personal observation as a primary learning mechanism is particularly true in investments where a personal experience can lead to people developing abiding aversions for specific corporations or types of stock which override any attempt at logic.  Moreover, people develop powerful beliefs about their ability to predict the future which transcend any evidence whatsoever.

Indeed the research strongly suggests that most people have no ability whatsoever to predict the future, and that most of their beliefs are based on a mistaken understanding of their own true natures.  It's not just that personal observation biases people but that their beliefs about their personal observations do as well.  You will think I'm biased, but you'll have a hard job believing that you are. This is true even when there's powerful, peer-reviewed and statistical evidence that contradicts the arguments being put forward.

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More on Mindful Money:

Things investors should hate 1/5: Models

Things investors should hate 2/5: Gurus

Things investors should hate 3/5: Innovation

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