Investors And The “Trifecta Of Failure”

What separates great investors from the rest? The Motley Fool’s Morgan Housel says it has to do not with financial acumen, but instead with psychological prowess.

While most investors are “mental catastrophes” the great ones “are masters of psychology,” Housel writes (h/t to The Big Picture). “They can’t control the market, but they have complete control over the gray matter between their ears.”

Housel says most investors suffer from a variety of cognitive biases, including cognitive dissonance, which makes people, for example, “criticize Wall Street for being a casino while checking your portfolio twice a day,” or sell stocks because the Federal Reserve is printing money only to blame the Fed’s money-printing when stocks rise. “Almost all of us do something similar with our money,” Housel writes. “We have to believe our decisions make sense. So when faced with a situation that doesn’t make sense, we fool ourselves into believing something else.” We also fall prey to confirmation bias, which causes us to seek out people with the same opinions as ourselves, reinforcing beliefs that could be faulty rather than challenging them. That and cognitive dissonance lead to a “trifecta of failure,” he says, in which investors “make a bad decision, rationalize it by fighting cognitive dissonance, and reinforce it with confirmation bias.”

Housel says that great investors are, however, “practically allergic” to such biases. Top strategist Mohnish Pabrai, for example, didn’t rationalize the losses he suffered in 2008; he studied his mistakes. “I clearly studied my own mistakes, and I went back systematically and documented why we lost money on these different investments,” he told Housel, adding that he then created a checklist he now consults before making decisions. “The checklist significantly brought down the error rate,” he said.

Housel says our biases are there, even if we don’t realize it. “And they’re preventing you from becoming a better investor,” he writes. “Fight them as hard as you can.”