Where Investors Fail Most Often

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1:56tuned in to the Investing for Beginners podcast. Led by Andrew Sather and Dave Ahern. Step-by-step premium investing guidance for beginners. Your path to financial freedom starts now. Starts now.

2:17All right, folks. Welcome to the Investing for Beginners podcast. Today, Andrew and I are going to break down some behavioral finance. We're going to talk about probably the most important thing about investing, the six to 10 inches between your ears, depending on how big your head is. That gray matter in your head is probably way more important than we give it credit for. And what we're going to do is we're going to talk through a little bit some ideas that we picked up from Charlie Munger's famous speech, The Psychology of Human Judgment. He is probably definitely one of the leaders in this area and idea.

2:56And Andrew and I were kind of revisiting this speech. And I got to tell you, it's a masterclass and you should read it slash listen to it as much as you possibly can. There is so much to mine from this. So we're just going to, we may not do it justice, but if you want to go to the source material, by all means, definitely check it out. So Andrew, let's start talking about the psychology of human misjudgment and some biases and maybe some things that we have learned along the way that could help people. Yeah. I mean, I think when we think about what's in our brain, you would hope for a nice organized library or a stack of textbooks of all the right investing books.

3:38Really, I think it's more like that Pixar movie where we just have a bunch of different colored monsters who all represent different emotions. And that's really what drives our decisions. and Charlie knew this as well as anybody and he was able to mitigate it and find great success despite the fact that it's hard to control emotions we can be very emotional and I love the way he described there's like two versions of the speech I guess so I don't know which version I'm referring to but he talked about how not a lot of people would like the idea of him basically skimming three psychology books and then having the nerve to make a whole speech about it.

4:21And there will be a lot of haters who look at him for displaying so much disregard for conventional wisdom while, quote, popping off on the subject in which he had never taken a course. And I love that he just lays it out like that and then proceeds to go on and make the speech anyway, which, like you said, has so many gems of wisdom and so many things that the more you think about like, wow, I guess I do have tendencies to do that. And wow, I better try to be aware that I can have those tendencies because a lot of those things can make us not as good of investors as we would like to be. And it's not just going to come naturally.

5:04I'm not just going to frolic through the fields of accounting books and spreadsheets and come to this great awareness of how I can make better decision making a speech like charlie munger's can help you get there so i like you said i don't think we'll do it much justice but hopefully we can we can uh telephone game at least one or two insights and i wholeheartedly agree with what you said like go to the source material because it is fantastic yep yep it is and uh little side note you can download the song as a song in Spotify and it's about an hour and 15 minutes. I used to listen to it years ago and Andrew and I were just actually downloading it a few minutes ago.

5:47So it is available on Spotify. So if reading is not your thing and you want to listen to it on a walk, for example, highly, highly recommend it. Put it on a repeat and listen to it for like months straight. Yeah. All right. So maybe not that, but let's talk about some cognitive biases that drive human behavior. I think a biggie and one that's probably most people are familiar with is something called confirmation bias. When I say those words, what does that mean to you? Confirmation bias is I'm going to seek out the information that I've already made my mind up about. And I'm going to ignore any other information that might be trying to tell me that I'm actually wrong.

6:30And we all do this. What it can do, obviously, hopefully, it is obvious. But if you've made up your mind before you've actually learned what the real reality of a business is, you'll make a lot of poor decisions. So rather than approaching a stock to say, I love this stock, and you've decided you love it on minute three of reading about the company, at that point, it doesn't matter how much more research you do. If you have confirmation bias, you're not actually researching or trying to find the answer. You're just finding things that confirm and make you feel like you're already correct. And you see this in politics all the time.

7:10And unfortunately, you see it in the stock market all the time. And it's not that easy. It's not as easy as finding your favorite company or finding the stock that everybody loves and just automatically thinking that that's going to be the next optimal return over the next five to 10 years. It's not that easy. And if you can get ahead of confirmation bias, you can become a much better stock picker. Yeah, for sure. How would you recommend people maybe take a stab at disconfirming confirmation bias? How can they avoid it, do you think? One of the things, which is hard because investing can be a solo game, But I like to, in our conversations with each other, I like to tell you, hey, I think I'm drinking the Kool-Aid here.

8:01Tell me what I'm missing. Because once I've drank the Kool-Aid, it's too late. And so having somebody who can provide you with outside perspective. so I guess to sum that up I'm seeking opposing opinions and this doesn't mean I'm necessarily wrong but it means I need to see what other people who haven't drunk the Kool-Aid are thinking about and what lens are they seeing about a company because I don't think every stock pick is different but I would say if you want to do a majority of the time a good stock pick, you should probably feel a little bad and a little good about. If you feel all good about a stock pick, you probably haven't done your research or you are buying a stock that's really expensive.

8:53Those would be the things I think trying to balance the emotions and trying, if you're feeling really romantic in a way about a stock, go out and intentionally look for reasons to not like a stock. Because you can always find bears and bulls on any company. Yeah, I love that. And I think that, to me, that's probably one of the better ways to do it is try to include opposite opinions of what yours is so that you can get input that may help dissuade you from drinking the Kool-Aid, so to speak, or at least give you a viewpoint from a different angle on something that you may not have considered. And that's why reading others' writings about a particular business can be helpful, especially when you're closer to the point of potentially making a decision and then looking at what the opposite side has to say about that.

9:49I know I've read about people that will actively seek out short reports or will seek out different information that will help kind of counteract their confirmation bias. and so they can try to look at the other side because it's so easy. It's so easy to drink the Kool-Aid and fall in love with a business or a CEO or a product and just get blindsided and just keep looking. Every information, seems like everything you look at goes, yep, yep, yep, yep. And that could be a dangerous place. And so it's really hard to keep an open mind and that's why it's so important to try to get outside of the echo chamber either in your own head or in the circle that you're operating in to get other points of view because that can be so enlightening.

10:39Well, the algorithm is actually designed to perpetuate your confirmation bias. There's a great documentary. I recommend it to everybody, even if you're not picking stocks. Do you remember what the name of it is? Social Experiment or something? Yeah, Social. Oh, gosh, what was it? Yeah, it was about the social. It was about meta. I think it was Facebook at the time, but Facebook, LinkedIn, Instagram, Twitter, like all those and how they were designed. Yeah, I'm blanking on the name of the, it'll come to me at 2.40 this morning. But yeah, it was a great show on Netflix for a long time. And it was really, it exposed how those algorithms work and how they're designed and how addictive they can be.

11:25Yeah, and also how it led to a lot of other riots and stuff that you see in politics and during elections and all this, and just all, like you said, the echo chambers. I'll give a silly example, but it's true. so I'm from Southern California I grew up on In-N-Out and I doesn't matter how many french fries that five guys will put in my bag that overflows my cup I do not care how many they will put in my bag I am an In-N-Out guy if I'm on Instagram and you are showing me you eating an In-N-Out burger I'm all about it I'm watching that and for some reason I seem to see more and more In-N-Out videos on my Instagram feed.

12:11So I am seeing all this confirmation that in fact, In-N-Out is the better burger chain. And by the way, I actually don't see much Five Guys in my Instagram. So that must mean, in fact, I am correct that In-N-Out is better than Five Guys. So would you look at that? The internet has given me great information. Affirmation bias. Thank you. 101.

12:41All right. So let's move on to the next confirmation bias that Charlie talked about, and that's the authority bias. The way I would, I guess, define it is you give an overweighted perception of somebody you look up to's opinion. So a perfect example for me would be Charlie Munger, Warren Buffett, Michael Mobison, Oswalt DeModerin, Monish Pabrai, all these people that I've looked up to, their opinion probably drives more of my bias on what they think because I've put them on a pedestal, so to speak. And Jimi Hendrix for the guitar, Eric Clapton for the guitar, Steve Ray Vaughan for the guitar, all those people, you put them on a pedestal and it's very easy to give them outsized authority.

13:32What they say is going to have a huge impact on how you think and how you behave. And so that's something you definitely have to work against. And it's hard. It's very difficult. So I'll flip it on you now. How do we fight against that? Because that's really hard, especially in investing where these guys have been so successful and they've weathered many cycles and they're obviously very smart guys. How do you make sure that we're not falling into this? I wouldn't say I'm perfect at this. This is a work in progress, shall we say. And one of the things for me is trying to read other people's opinions and to set aside those influences and try to learn from other people and then try to incorporate those other people's opinions.

14:26and maybe a perfect example is we just had David Gardner from The Motley Fool on the show. And he has some Buffett-isms in him, but he has other not, very decidedly not Buffett-isms in there. And so after reading his book and listening to your great interview with him, there's a lot of things you can pick up from him. He's been very successful as an investor. And so you have to decide, I have to decide, are some of the things that David proposes are things that fit with me personally, with my emotional state and with my mental state and how I can invest and balance that with what Charlie and Warren have taught me all these years.

15:11And so I think it's a little bit about trying to balance your influences. And so for me, the way I try to work through it, I'm not saying this is the ideal way to do it. And hopefully you have a better way. But the way that I do it is I try to read other people's writings and try to think about their influence and how that could impact taking the base of what I've learned from these other people and try to add this and try to make it my own, so to speak. I'm relating this to the music thing because that's what you have to do when you're a musician. You imitate. At the beginning, you don't know what you're doing, right?

15:48So you have to imitate Jimmy. And you have to imitate Steve Ray Vaughan or B.B. King if you want to be a blues guitar player. You have to mimic those guys. You have to learn what they play, play their solos note for note, all this kind of thing. But over time, you start to pick up other influences. Because Steve Ray Vaughn or Steve Vai or Joe Satriani were nothing like those guys. But then you start to pick up what they're doing and then it kind of becomes your own, so to speak. And so maybe that's, I'm not sure if that's not a great analogy, but that's what I've kind of tried to do with investing in those authority figures for me.

16:23Yeah, I love that. I mean, I don't think I have a better solution than that. my tendencies have been to think that history will repeat closer than it ever does. And so I guess one of the ways, I don't think I've actually tried to do this consciously, but now that I realize it probably should be a more conscious effort is just to be more, because when I started, I was all about history, history, history. Like one of the things I remember picking up very early on as an investor. And just if you read books in general, this tends to be true, is the idea that the best books are the ones that have been the best sellers the longest.

17:06Because there's just so many books that just come and go, and they come and go, and they come and go. So if you really want to read the best material, it tends to be the material that's been the best seller for 50 years. Benjamin Graham, Joel Greenblatt, right? Like these guys who knew what they were talking about, And their wisdom is timeless. So I think I definitely spent too much time in that world and not enough time in today's world. And when I started to take the advice that you would prescribe on our show and that we would talk about of, hey, read a lot of 10Ks, listen to our earnings calls, get yourself out of the past and look at what's happening in the present, to me that helps because I think I emulated a little bit too closely whatever great investors were doing in the past, and it's a different world.

17:59So you can't just take that authority figure and how he invested and duplicate it today because it's a different world. It's not going to work. Even though a lot of the principles will stay the same, you can't follow it too closely. You can't let this bias get to you. That was one way, I think. In hindsight now, and I was worried because you kind of put me on the spot, But I think in hindsight, that was something that was a way to kind of counteract that. And I think it could be helpful if people struggle with that today. Yep. Yep. For sure. I think it's a real easy bias to fall into under, especially in the investing world, especially when you're newer to the whole investing game is to find somebody that really resonates with you.

18:42and to really, I'm not saying it's a bad thing, but at some point you have to kind of, you have to start to try to be your own person because the way Peter Lynch invests or the way that Bill Ackman invests may not fit your personality. And so that's where this, you have to start working past that bias. And the reason why Charlie brought these all up are because these are all things that we all struggle with. And he's trying to point out ways that we can potentially move past those so that we can try to be our own person. And ultimately, that's what he's trying to get at. All right. Let's move on to the next one, which is social proof.

19:21This is in this day and age of social media, this is very dangerous. Yeah. How would you describe it, I guess, in today's day and age? Because maybe he even described it a little bit differently. I don't know if this... I'm pretty sure the speech was before the internet. So how would you describe it in today's day and age? today's day and age, I would say that it really comes down to, well, so-and-so did this, or so-and-so said that, or I saw so-and-so do this on Instagram, so it must be a good thing, or it must be right. It would be a little hanging fruit to throw Alex Hormozzi under the bus, because he's one of the largest followed people, and a lot of people treat what he says as gospel.

20:03and I'm not saying he's wrong. I don't read him. I don't listen to him. It's not a person I follow, which is fine. But I would say that there's a lot of disciples of his and I think a lot of people, because he says something to do it, that they go out and do it and he has a huge following. So he has a huge influence on people and it could be a dangerous path to follow. Again, if it doesn't fit you and your personality or the way that you want to operate or live your life, and that can make it challenging. I'm not saying it's good or bad, but I am saying that it can be dangerous if it doesn't fit who you are.

20:42Yeah, I agree with that. Nothing to add there. I guess one thing that did pop to my mind is I think there's some social proof in the type of stocks you buy. And I've just noticed this with myself personally is when I have stocks that I've bought recently that everybody can relate to when I tell them about the stock, I get that kind of social proof confirmation or reassurance where if I'm telling you that I bought Progressive Insurance or even something like Crocs, which I've mentioned over and over again on the show, people know those names. And so they'll be like, oh, okay, cool. But if I mention Apulte Group or I mentioned like a B2B.

21:31See, I mean - Something like Simpson Manufacturing, for example. Yeah, yep, perfect. Most people, including me, when you first mentioned it, blank stare. Like, who? Right, yeah. And then you see how it has such a little mind share in my mind now because it's just not, it just sits in my portfolio and grows earnings and doesn't feel as flashy as buying Apple on a dip and being really proud of that moment. So that can be dangerous as an investor because we're not investing, we're not picking stocks to feel good about ourselves or feel like, hey, I can be the cool kid on campus every time I talk to people and tell them the stocks I'm buying.

22:13We should be buying stocks to make money and do it in a safe and consistent and sustainable way. So obviously it's very evident from what I just said that I struggle with this. And I don't know if I have a good solution, but at least maybe being aware that it's there. If I find myself feeling really good about Apple or progressive insurance, that may be, hey, cool the jets and relax and realize, okay, look at it objectively, go back to how you beat confirmation bias, go through those steps and keep that balanced emotion around how you feel about stock. Yeah, that's really good advice. How many times have you either come across an idea or invested in a company and either find out later that some super investor, oh, Bill Ackman bought the same thing?

23:09You know, it does give you a little endorphin rush, you know, because, whoa, hey, you know, I might be onto something here because, you know, somebody that you look up to bought the same thing or vice versa. You're doing research on a company you're interested in. Somehow you come across the fact that some other super investor owns the company that you're interested in. And that can lead to being more open to buying it because you're influenced by by them. One thing we should probably mention about a lot of these biases is sometimes they can stack. So authority bias and social proof can kind of stack on top of each other and then you start adding confirmation bias into all that and it becomes this nice little soup of human emotions that you have to swim through to get to the other side of what you're trying to do.

23:58So it is something you have to be aware of. And I like what you said about we may not have the antidote, but I think if you're at least aware of these, then it can maybe help prevent you or at least give you pause. Okay, so Bill Ackman bought it. How do I feel about that? Do I care? And if you do, then you maybe ask yourself, why do you care? And if you don't care, then okay, move on, check and move on to the next thing. But I think if you understand it, I think it's an easier place to at least try to start to move past some of them. Yeah, love it. You may have heard about BILT as the loyalty program that lets you earn points on rent wherever you live.

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27:19This is one of my favorites. Oh, really? So please take first serve. Well, I think this is the power of incentives is something that I think once you see it, you can't unsee it. And when you think about what drives behavior for certain things, I think it's very evident in the stock market and it's even more evident in politics. And I don't want to dive into the politics part, but in the stock part of it, you'll see it very, very evidently. The power of incentives will basically drive the behavior. So kind of the way to think about what does this mean is the reason people are doing the thing is because there's an incentive driving them to do it.

28:07They're going to get some sort of reward, whether it's monetary, whether it's public acknowledgement, whether it's internal gratification. There's something that's causing them to push forward an idea or a particular product or project. And an easy way to visualize this is to think about a CEO of a business. If you listen to the earnings report and they're talking about adjusted earnings, for example, and just throw that out there. If they're talking about adjusting earnings for the entire hour of the earnings presentation slash interview with analysts, you can bet your bottom dollar that they're being incentivized.