Behavioural Finance: We are hardwired to be lousy investors.

1.  We are hardwired from birth to be lousy investors.

Our survival instincts make us fear loss much more than we enjoy gain.  We run from danger first and ask questions later.  We panic out of our investments when things look bleakest - we are just trying to survive!  We have a herd mentality that makes us feel more comfortable staying with the pack.  So buying high when everyone else is buying and selling low when everyone else is selling comes quite naturally - it just makes us feel better!

We use our primitive instincts to make quick decisions based on limited data and we weight most heavily what has just happened.  We run from managers who performed poorly most recently and into the arms of last year's winners - that just seems like the right thing to do!  We all think we are above average!  We consistently overestimate our ability to pick good stocks or to find above-average managers.  It is also this outsized ego that likely gives us the confidence to keep trading too much.  We keep making the same investing mistakes over and over - we just figure this time we will get it right!

We are busy surviving, herding, fixating on what just happened and being overconfident!  Maybe it helps explain why Mr. Market acts crazy at times.

2.  So, how do we deal with all these primitive emotions and lousy investing instincts?  

The answer is really quite simple:  we don't!

Let's admit that we will probably keep making the same investing mistakes no matter how many books on behavioural investing we read.

3.  How to invest in the stock market?

Traditionally, stocks have provided high returns and have been a mainstay of most investors’ portfolios. Since a share of stock merely represents an ownership interest in an actual business, owning a portfolio of stocks just means we’re entitled to a share in the future income of all those businesses. If we can buy good businesses that grow over time and we can buy them at bargain prices, this should continue to be a good way to invest a portion of our savings over the long term. Following a similar strategy with international stocks (companies based outside of the United States) for some of our savings would also seem to make sense (in this way, we could own businesses whose profits might not be as dependent on the U.S. economy or the U.S. currency)

4.  These words of wisdom from Benjamin Graham

In an interview shortly before he passed away, Graham provided us with these words of wisdom:

The main point is to have the right general principles and the character to stick to them.… The thing that I have been emphasizing in my own work for the last few years has been the group approach.  To try to buy groups of stocks that meet some simple criterion for being undervalued—regardless of the industry and with very little attention to the individual company.… Imagine—there seems to be practically a foolproof way of getting good results out of common stock investment with a minimum of work. It seems too good to be true. But all I can tell you after 60 years of experience, it seems to stand up under any of the tests that I would make up.

That interview took place thirty-five years ago. Yet we still have an opportunity to benefit from Graham’s sage advice today.

I wish you all—the patience to succeed and the time to enjoy it. Good luck.

Book:  Joel Greenblatt:  The Big Secret for the Small Investor (2001)

Regret Theory

Fear of regret, or simply regret theory deals with the emotional reaction people experience after realizing they've made an error in judgment.

Faced with the prospect of selling a stock, investors become emotionally affected by the price at which they purchased the stock.

• So, they avoid selling it as a way to avoid the regret of having made a bad investment, as well as the embarrassment of reporting a loss.  We all hate to be wrong, don't we?

What investors should really ask themselves when contemplating selling a stock is:
"What are the consequences of repeating the same purchase if this security were already liquidated and would I invest in it again?"

• If the answer is "no," it's time to sell; otherwise, the result is regret of buying a losing stock and the regret of not selling when it became clear that a poor investment decision was made – and a vicious cycle ensues where avoiding regret leads to more regret.

• Regret theory can also hold true for investors when they discover that a stock they had only considered buying has increased in value.

Some investors avoid the possibility of feeling this regret by following the conventional wisdom and buying only stocks that everyone else is buying, rationalizing their decision with "everyone else is doing it."

• Oddly enough, many people feel much less embarrassed about losing money on a popular stock that half the world owns than about losing money on an unknown or unpopular stock.

Psychology and Investing: Herding

Stock Ideas

There are thousands and thousands of stocks out there.  Investors cannot know them all.

In fact, it is a major endeavor to really know even a few of them.

But people are bombarded with stock ideas from brokers, television, magazines, Web sites, and other places.





Herding Behaviour

Inevitably, some decide that the latest idea they have heard is better idea than a stock they own (preferably one that is up, at lead), and they make a trade.

In many cases the stock has come to the public's attention

• because of its strong previous performance, 
• not because of an improvement in the underlying business.

Following a stock tip, under the assumption that others have more information, is a form of herding behaviour.





Temporary Comfort from investing with the Crowd or a Market Guru

This is not to say that investors should necessarily hold whatever investments they currently own.

Some stocks should be sold, whether because

• the underlying businesses have declined or 
• their stock prices simply exceed their intrinsic value.

But it is clear that many individual (and institutional) investors hurt themselves by making too many buy and sell decisions for too many fallacious reasons.  

We can all be much better investors when we learn to select stocks carefully and for the right reasons, and then actively block out the noise.

Any temporary comfort derived from investing with the crowd or following a market guru can lead to fading performance or inappropriate investments for your particular goals.

Psychology and Investing: Mental Accounting and Framing Effect

Most of us separate our money into buckets - this money is for the kids' college education, this money is for our retirement, this money is for the house.   Heaven forbid that we spend the house money on a vacation.

Investors derive some benefits from this behaviour.

• Earmarking money for retirement may prevent us from spending it frivolously.

Mental accounting becomes a problem, though, when we categorize our funds without looking at the big picture.

• While we might diligently place any extra money left over from our regular income into savings, we often view tax refunds as "found money" to be spent more frivolously.  
• Since tax refunds are in fact our earned income, they should not be considered this way.
• For gamblers, this effect can be referred to as "house money."

We are much more likely to take risks with house money than with our own.

• There is a perception that the money isn't really ours and wasn't earned, so it is okay to take more risks with it.  
• This is risk we would be unlikely to take if we would spent time working for that money ourselves.

In investing, just remember that money is money, no matter whether the funds in a brokerage account are derived from hard-earned savings, an inheritance or realized capital gains.




Framing Effect

This is one other form of mental accounting.

The framing effect addresses how a reference point, oftentimes a meaningless benchmark, can affect decision.





Overcoming Mental Accounting.

The best way to avoid the negative aspects of mental accounting is to concentrate on the total return of your investments.

Take care not to think of your "budget buckets" so discretely that you fail to see how some seemingly small decisions can make a big impact.

Psychology and Investing: Confirmation Bias and Hindsight Bias

Confirmation Bias

How do we look at information?

Too often we extrapolate our own beliefs without realizing it and engage in confirmation bias, or treating information that supports what we already believe, or want to believe, more favourably.

If we have purchased a certain stock in a certain sector, we may overemphasize positive information about the sector and discount whatever negative news we hear about how these stocks are expected to perform.


Hindsight Bias

This is the tendency to re-evaluate our past behavior surrounding an event or decision knowing the actual outcome.

Our judgment of a previous decision becomes biased to accommodate the new information. 

For example, knowing the outcome of a stock's performance, we may adjust our reasoning for purchasing it in the first place. 

This type of "knowledge updating" can keep us from viewing past decisions as objectively as we should.

Psychology and Investing: Anchoring

When estimating the unknown, we cleave to what we know.

Investors often fall prey to anchoring.

They get anchored on their own estimates of a company's earnings, or on last year's earnings.

For investors, anchoring behaviour manifests itself in placing undue emphasis on recent performance since this may be what instigated the investment decision in the first place.

When an investment is lagging, we may hold on to it because we cling to the price we paid for it, or its strong performance just before its decline, in an effort to "break even" or get back to what we paid for it.

We may cling to sub-par companies for years, rather than dumping them and getting on with our investment life.

It is costly to hold on to losers, though, and we may miss out on putting those invested funds to better use.



Overcoming Anchoring

It may be helpful to ask yourself the following questions about your stocks:

Would I buy this investment again?

And if not, why do I continue to own it?

Truthfully answering these questions can help you severe the anchors that may be a drag on your rational decision making.

Psychology and Investing: Sunk Costs

Sunk cost fallacy is another factor driving loss aversion.

This theory states that we are unable to ignore the "sunk costs" of a decision, even when those costs are unlikely to be recovered.

Our inability to ignore the sunk costs of poor investments causes us to fail to evaluate the situation on its own merits.

Sunk costs may also prompt us to hold on to a stock even as the underlying business falters, rather than cutting our losses.    

[?Had the dropping stock been a gift, perhaps we wouldn't hang on quite so long.]

Psychology and Investing: Loss Aversion

Loss Aversion

Many investors will focus obsessively on one investment that is losing money, even if the rest of their portfolio is in the black.  This behaviour is called loss aversion.

Investors have been shown to be more likely to sell winning stocks in an effort to "take some profits," while at the same time not wanting to accept defeat in the case of the losers.

"More money has probably been lost by investors holding a stock they really did not want until they could 'at least come out even' than from any other since reason." (Philip Fisher, Common Stocks and Uncommon Profits).

Regret also comes into play with loss aversion.

This may lead us to be unable to distinguish between a bad decision and a bad outcome.

"We regret a bad outcome, such as a stretch of weak performance from a given stock, even if we chose the investment for all the right reasons.  In this case, regret can lead us to make a bad sell decision, such as selling a solid company at a bottom instead of buying more."

We tend to feel the pain of a loss more strongly than we do the pleasure of a gain. 

It is this unwillingness to accept the pain EARLY that might cause us to "ride losers too long" in the vain hope that they'll turn around and won't make us face the consequences of our decisions.

Psychology and Investing: Self-handicapping

Self-handicapping bias occurs when we try t o explain any possible future poor performance with a reason that may or may not be true.

This behaviour could be considered the opposite of overconfidence.

As investors, we may also succumb to self handicapping, perhaps by admitting that we didn't spend as much time researching a stock as we normally had done in the past, just in case the investment doesn't turn out quite as well as expected.

Both overconfidence and self-handicapping behaviours are common among investors, but they aren't the only negative tendencies that can impact our overall investing success.

Psychology and Investing: Selective Memory, Cognitive dissonance and Representativeness

Selective Memory

Few of us want to remember a painful event or experience in the past, particularly one that was of our own doing.

In terms of investments we certainly don't want to remember those stock calls that we missed (had I only bought eBay in 1998), much less those that proved to be mistakes which ended in losses.

Such memories threaten our self-image.



Cognitive dissonance

How can we be such good investors if we made those mistakes in the past?

Instead of remembering the past accurately, in fact, we will remember it selectively so that it suits our needs and preserves our self-image.

Incorporating information in this way is a form of correcting for cognitive dissonance, as well-known theory in psychology.

Cognitive dissonance posits that we are uncomfortable holding two seemingly disparate ideas, opinions, beliefs, attitudes, or in this case, behaviours, at once, and our psyche will somehow need to correct for this.

"Perhaps it really wasn't such a bad decision selling that stock?"

"Perhaps, we didn't lose as much money as we thought?"

Over time, our memory of the event will likely not be accurate but will be well integrated into a whole picture of how we need to see ourselves.



Representativeness

Another type of selective memory is representativeness, which is a mental shortcut that causes us to give too much weight to recent evidence - such as short-term performance numbers - and too little weight to the evidence from the more distant past.  As a result, we will give too little weight to the real odds of an event happening.

Psychology and Investing: Overconfidence

Overconfidence refers to our boundless ability as human beings to think that we are smarter or more capable than we really are.

Such optimism isn't always bad.  Certainly we would have a difficult time dealing with life's many setbacks if we were die-hard pessimists.

However, overconfidence hurts us as investors when we believe that we are better able to spot the next Microsoft than another investor is.  Odds are, we are not.

Studies show that overconfident investors trade more rapidly because they think they know more than the person on the other side of the trade.  Trading rapidly costs plenty and rarely rewards the effort.  Trading costs in the form of commissions, taxes, and losses on the bid-ask spread have been shown to be a serious damper on annualized returns.  These frictional costs will always drag returns down.

One of the things that drive rapid trading, in addition to overconfidence in our abilities, is the illusion of control.  Greater participation in our investments can make us feel more in control of our finances, but there is a degree to which too much involvement can be detrimental, as studies of rapid trading have demonstrated.

Successful investing requires the rare ability to identify and overcome one's own psychological weaknesses.

Successful investing is hard, but it doesn't require genius.

Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.

Successful investing requires the rare ability to identify and overcome one's own psychological weaknesses.

Behavioural finance attempts to explain why people make financial decisions that are contrary to their own interests.

Behavioural finance has a lot to offer in terms of understanding psychology and the behaviour of investors, particularly the mistakes that they make.  

Much of the field attempts to extrapolate larger, macro trends of influence, such as how human behaviour might move the market.

We can also focus on how the insights from the field of behavioural finance can benefit individual investors.  Primarily, we are interested in how we can learn to spot and correct investing mistakes in order to yield greater profits.


Some insights one can focus on in behaviour finance are:

• Overconfidence
• Selective Memory
• Self-Handicapping
• Loss Aversion
• Sunk Costs
• Anchoring
• Confirmation Bias
• Mental Accounting
• Framing Effect
• Herding

Psychological Biases

Loss Aversion

Behavioural finance asserts that investors exhibit loss aversion, that is, they dislike losses more than they like comparable gains.

This results in a strong preference for avoiding losses as opposed to achieving gains.

Advocates of this bias argue that loss aversion is more important to investors than risk aversion,, which is why the "overreaction" anomaly is observed.

While loss aversion can explain the overreaction anomaly, studies have shown that under reactions are just as common as overreactions, which counters the assertions of this bias.



Herding

Herding behaviour is a behavioural bias that explains both under reactions and overreactions in financial markets.

Herding occurs when investors ignore their own analysis, and instead make investment decisions in line with the direction of the market.



Overconfidence

Overconfdence bias asserts investors have an inflated view of their ability to process new information appropriately.

Overconfident investors are inaccurate when it comes to valuing securities given new information, and therefore stocks will be mispriced if there is an adequate number of such investors in the market.

Evidence has suggested that overconfidence has led to mispricing in most major markets around the world, but the bias has been observed predominantly in higher-growth companies, whose prices are slow to factor in any new information.

Another aspect of this bias is that overconfident investors tend to maintain portfolios that are less-than-optimally diversified because they tend to overestimate their stock-picking abilities.




Information Cascades

An information cascade refers to the transfer of information from market participants who are the first to take investment action upon the release of new information, and whose decisions influence the decisions of others.

Studies have shown that information cascades tend to be greater for stocks when reliable and relevant information about the underlying company is not easily available.




Representativeness

Investors assess probabilities of future outcomes based on how similar they are to the current state.



Mental Accounting

Investors tend to keep track of gains and losses from different investments in separate mental accounts.



Conservatism

Investors are slow to react to changes and continue to maintain their initial views.



Narrow framing

Investors focus on issues in isolation

Behavioural Finance

Behavioural finance looks at investor behaviour to explain 

• why individuals make the decisions that they do, 
• whether these decisions are rational or irrational.

It is based on the premise that individuals, due to the presence of behavioural biases:

• do not always make "efficient" investment decisions, or 
• do they always act "rationally" 

These behavioural biases include:

• Loss Aversion
• Herding
• Overconfidence
• Information Cascades
• Representativeness
• Mental Accounting
• Conservatism
• Narrow Framing

Whether investor behaviour can explain market anomalies is a subject open to debate.

• If investors must be rational for the market to be efficient, then markets cannot be efficient.
• If markets are defined as being efficient, investors cannot earn superior risk-adjusted profits consistently. 

Psychology and Investing

You must have faith in your own research, rather than in luck.

Your actions are derived from carefully thought out goals, and you are not swept off course by short-term events.

You understand the true elements of risk and accept the consequence with confidence.

In the business world, you can find huge predictable patterns of extreme irrationality.

This is not talking about predicting the timing, but rather the idea that when irrationality does occur, it leads to predictable patterns of subsequent behaviour.

You should pay serious attention to the intersection of finance and psychology.

The majority of investment professionals have only recently paid serious attention to this.

Your own understanding of this will be valuable in your own investing.

The Psychology of Investing. Emotions affect people's behaviour and ultimately market prices.

The emotions surrounding investing are very real.  These emotions affect people's behaviour and ultimately, affect market prices.

Understanding the human dynamic (emotions) is so valuable in your own investing for these two reasons:

1. You will have guidelines to help you avoid the most common mistakes.
2. You will be able to recognise other people's mistakes in time to profit from them.

We are all vulnerable to individual errors of judgement, which can affect our personal success.

When a thousand or a million people make errors of judgement, the collective impact pushes the market in a destructive direction.

The temptation to follow the crowd can be so strong that accumulated bad judgement only compounds itself.

In this turbulent sea of irrational behaviour, the few who act rationally may well be the only survivors.

To be a successful focus investor:

• You need a certain kind of temperament.
• The road is always bumpy and knowing which is the right path to take is often counterintuitive.
• The stock market's constant gyrations can be unsettling to investors and make them act in irrational ways.
• You need to be on the lookout for these emotions and be prepared to act sensibly even when instincts may strongly call for the opposite behaviour.
• The future rewards focus investing significantly enough to warrant our strong effort.

A little COMMON SENSE goes a long way to Improve Investment Results! The mistakes of some investors may be the profit opportunities for others.

Investors' decisions are affected by a number of psychological biases that lead investors to make systematic, predictable mistakes in certain decision-making situations.

These mistakes, in turn, may lead to predictable patterns in asset prices that create opportunities for other investors to earn abnormally high profits without accepting abnormally high risk.


Here are some of the behavioural factors that might influence the actions of investors:

1.  Overconfidence and Self-Attribution Bias
2.  Loss Aversion
3.  Representativeness
4.  Narrow Framing
5.  Belief Perseverance
6.  Familiarity Bias


Using Behaviour Finance to Improve Investment Results

Studies have documented a number of behavioural factors that appear to influence investors' decisions and adversely affect their returns.

By following some simple guidelines, you can avoid making mistakes and improve your portfolio's performance.

A little common sense goes a long way in the financial markets!


1.  Don't hesitate to sell a losing stock.

If you buy a stock at $20 and its price drops to $10, ask yourself whether you would buy that same stock if you came into the market today with $10 in cash.  

If the answer is yes, then hang onto it.

If not, sell the stock and buy something else.


2.  Don't chase performance.

The evidence suggests that there are no "hot hands" in investment management.

Don't buy last year's hottest mutual fund if it doesn't make sense for you.

Always keep your personal investment objectives and constraints in mind.


3.  Be humble and open-minded.

Many investment professionals, some of whom are extremely well paid, are frequently wrong in their predictions.

Admit your mistakes and don't be afraid to take corrective action.

The fact is, reviewing your mistakes can be a very rewarding exercise - all investors make mistakes, but the smart ones learn from them.

Winning in the market is often about not losing, and one way to avoid loss is to learn from your mistakes.


4.  Review the performance of your investments on a periodic basis.

Remember the old saying, "Out of sight, out of mind."

Don't be afraid to face the music and to make changes as your situation changes.

Nothing runs on "autopilot" forever - including investment portfolios.


5.  Don't trade too much

Investment returns are uncertain, but transaction costs are guaranteed.

Considerable evidence indicates that investors who trade frequently perform poorly.




Implications of Behavioural Finance for Security Analysis

Behavioural finance can play an important role in investing.

The contribution of behavioural finance is 

• to identify particular psychological factors that can lead investors to make systematic mistakes, and 
• to determine whether those mistakes may contribute to predictable patterns in stock prices.

If that is the case, the mistakes of some investors may be the profit opportunities for others.

See the above 5 common sense rules on how to keep your own mistakes to a minimum.

Charlie Munger on Thinking errors and Misjudgements (Summary)

Summary:

Do we behave to environmental stimuli like ants?

1.  Reward and Punishment Super-response Tendency 

(Incentive and disincentive-caused bias.  It is imperative to understand the role of incentives and disincentives in changing cognition and behavior. The power of incentives can be used to produce desirable behavioural changes.  An incentive-caused bias can tempt people into immoral behaviour.  If you rip apart any system and look at its core design, you will find mainly two things: incentives and disincentives. Communism has failed due to the absence of exactly those incentives. The US financial crisis was an outcome of wrong incentives and absence of disincentives.   It is quite clear that man responds more often and more easily to incentives than to reason and conscience. )

2.  Liking and Loving Tendency 

(This tendency to love has its own set of side effects.  Don't fall in love with your stocks.  Fall in love and protect your capital.  Be a disciplined value investor!)

3. Doubt-avoidance Tendency

(Quick conclusions and quick decisions are often preferred instead of the burden of doubts and ambiguity.  When neither under pressure nor threatened, a person should ideally not be prompted to remove doubt through rushing to some decision.)

4.  Inconsistency-avoidance Tendency 

(We tend to filter away any piece of information which may be inconsistent with our ideas and beliefs.  Be disciplined with your approach:  play the devil's advocate or have processes and procedures in place that tend to minimize hasty and biased decision making.  Adjourn your stock purchases till you are sure.  Stock markets will always keep swinging higher and lower.  Investing opportunities will be there.)

5.  Envy and Jealousy Tendency  

(Greed is fuelled by envy.  Everyone is here not just to make money, but to make more money than what the next person is making.  Comparison and competition are intense, creating a perfect recipe for jealousy tendency.  The important point to take home is to not let such negative emotions affect your investment decisions. Avoid discussions that would trigger feelings of jealousy.  Keep extremely low profile and keep discussions to stock ideas and business fundamentals.)

6.  Over-optimism tendency  

(Excess of optimism is the normal human condition.  "What a man wishes, that also will he believe."  The best way is to acknowledge that this bias exists in the first place.  Challenge your views by asking yourself as many questions as possible to see if your views can stand the attack of reason.)

7.  Social proof tendency

( It is an automatic tendency to think and act the way people around you are thinking and acting.  The evil of corruption continues to persist because of the Serpico Syndrome, which is created by the social proof tendency and the power of incentives.  It dominates how investors behave in stock markets, how company managements (institutional imperative) do business and so on.  Have the management act as if they were the owners.  Buffett says, "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.)

8.  Contrast Misreaction Tendency 

(We perceive everything in relative terms.  It influences how we think about economic news and information, corporate performance, stock prices and so on.  Contrast misreaction cause people to make wrong judgements based on misleading contrasts between two or more things and situations.  For example, a person shifting to another city and looking for a new house and his estate agent using this trick on him.  For the investor, why he did not buy the stock at 140 (because it rose from 90) and then he bought the same stock at 300 (because it fell from 450)?  A stock with P/E of 50 in past and is now at P/E of 30 does not mean it is a lucrative buying opportunity.  Look at the company's business fundamentals and its past financial track record.  Valuing the company based on such important parameters will help you avoid false comparisons.)

9.  Availability-misweighing Tendency  

(Due to the relentless flow of news and information, the human mind has a tendency to focus on what's easily available.  In doing so, often tend to give undue importance to it.  In the absence of relevant information, investors often end up giving undue importance to such insignificant matters.  Adopt Charles Darwin's approach.  He would try to gather evidence to disconfirm it.  Challenge the merit of the idea.  Look for potential risks and concerns that could adversely affect the company.  The ultimate investing decision should be based solely on your understanding and insght and not from borrowed optimism.  Be discipline.  To avoid falling prey to this tendency is to prepare an investment check list and adhere to the process in a disciplined manner.)

10.  Use-it-or-lose-it Tendency  

(The importance of regular practice is especially very vital in skills of a very higher order.  Many people take investing as a side business which can be done without putting in too much time and effort.  And that is one of the biggest fallacies.  Legendary investors such as Warren Buffett, Charlie Munger and Peter Lynch did not create great fortunes out of thin air. They are known to be rigorous practitioners of their art.  They all read extensively and spend a huge amount of their daily routine analysing companies.  By using their mental skills meticulously, they have become successful pilots of the investing world.)

11.  Senescence-misinfluence Tendency  

(At an age when you may not be in the best physical frame to travel distances and perform demanding tasks, what could you do for an alternative source of income?  The answer is investing.  The real risk of significant losses lies in speculative short-term trading.  If you choose the path of long term value investing, you will not only live with minimal risk, but the chances of immense profits will be significantly high.  Remember, in the long run, equities tend to outperform all major asset classes.  If you develop useful skills early in your life and practice them rigorously over the years, you could manage to retain those skills for a much longer period, despite the aging process.)

12.  Authority-misinfluence Tendency  

(Uncertainty and risk have a big influence on how independently people take their decisions.  This makes the stock market a place that is incurably afflicted by the authority-misinfluence tendency.  Just spare a moment and ponder about how exactly you decide when to buy or sell a stock.  What makes you follow these experts?  It is important that you exercise your own independent judgement to the opinions of others.  "Mr. Market is there to serve you, not to guide you."  The greatest investors in the world are those who do not give in to the moods of Mr. Market.  (Mr. Market is a parable told and popularised by Benjamin Graham, teacher of Warren Buffett.)

13.  Twaddle Tendency  

(Man often indulges in petty small talks and chatter.  They only become a nuisance when they come in the way of some serious work that is in progress.  This twaddle tendency, like the twaddle dance of the honey bees, can lead to unproductive results.  And this is what we need to keep a check on.   Better to stay in a quiet corner meantime rather than doing something silly, irrelevant or unproductive.)

Charlie Munger on Thinking errors and Misjudgements

Charlie Munger developed his own system of psychology.  These have very powerful implications for investors.

Do we behave like ants?

The ant merely responds to stimuli (e.g. pheromone) with a few simple responses programmed into its nervous system by its genes.

Under complex circumstances, don’t we also find ourselves behaving counterproductively just like ants?

Aren’t the stock markets a perfect playground for this kind of behavior?

1.  Reward and Punishment Super-response Tendency

All creatures seek their own self-interest.

Our innate drive is to maximize pleasure while at the same time avoiding or reducing pain.

It is imperative to understand the role of incentives and disincentives in changing cognition and behavior.

The power of incentives can be used to produce desirable behavioural changes.

An incentive-caused bias can tempt people into immoral behaviour.

Human nature, bedeviled by incentive-caused bias, causes a lot of ghastly abuse.

It is important to understand the motives and incentives of people and organizations you are dealing and investing with.

Widespread incentive-caused bias requires that one should often distrust or take with a grain of salt, the advice of one’s professional advisor.

If you rip apart any system and look at its core design, you will find mainly two things: incentives and disincentives.

The success or failure of any economic system depends on how incentives and disincentives are designed.

The success of the free-market system as an economic system comes from its inherent reward-punishment mechanism.

Communism has failed due to the absence of exactly those incentives. 

The US financial crisis was an outcome of wrong incentives and absence of disincentives.  

The crisis was a failure of the entire system. 

 “Incentives were horribly skewed in the financial sector, with the workers reaping rich rewards for making money but being only lightly penalized for losses.”

It is quite clear that man responds more often and more easily to incentives than to reason and conscience. 

2.   Liking and Loving Tendency

Love is one of the most basic of emotions.

It extends not only towards people but also towards things, ideas and concepts.

This tendency to love has its own set of side effects.

Now ask yourself these questions:

·                     Do you tend to ignore their faults? Do you readily comply with their wishes?

·                     Do you favour people, products, and actions merely associated with them?

·                     Do you distort any unpleasant facts about them?

We dislike challenging and reasoning with things and ideas that we love.

Do fall in love, but not with your stocks.  

Love your capital and do the best you can to protect it and to help it grow. 

Be a disciplined value investor!

3.   Doubt-avoidance tendency

Doesn't our mind often display a tendency to steer clear of doubts to quickly reach a decision or conclusion?

But the problem with any kind of psychological tendency or mental programming is that it doesn't work well in all situations. 

A person who is neither under pressure nor threatened should ideally not be prompted to remove doubt through rushing to some decision.

Yet, more often than not we find ourselves doing exactly the opposite.

When a person comes to the stock markets with a bag full of money to invest, he is usually inclined to fall in love with any stock that seems promising. 

The boredom and pain that is usually part of a thorough scrutiny and analysis of a stock is often avoided.

Quick conclusions and quick decisions are often preferred instead of the burden of doubts and ambiguity. 

If you learn how to reign over the doubt-avoidance tendency while you conduct your business in the stock markets, there is little that can stop you from becoming a successful investor. 

4.  Inconsistency-avoidance tendency

While habits can be good, and good habits doubly so, there are several disadvantages as well. 

Habits often come in the way of any kind of change or transformation. 

As Charlie Munger puts it very aptly, "People tend to accumulate large mental holdings of fixed conclusions and attitudes that are not often reexamined or changed, even though there is plenty of good evidence that they are wrong." 

The inconsistency-avoidance tendency is very rampant amongst human beings. In simple words, we filter away any piece of information which may be inconsistent to our ideas and beliefs.

Stock markets are largely driven by sentiment. So you must do your best to be as objective as you can and guard yourself from the lures of greed and fear. 

Getting back to inconsistency-avoidance tendency, can you remember instances when you have used this tendency to your own peril?

Have you lost money on your favourite stock that had once been an outperformer? 

The company's prospects may have changed, it may no longer be worth putting your money into, but you still couldn't let go of it. Why?

Because letting go of it would be inconsistent with your original beliefs about it.

So you did everything to console and convince yourself that nothing was wrong.

But your portfolio losses have a different story to say, don't they? 

How exactly do you get rid of this tendency?   You need to be very disciplined with your approach. 

·                     One great way is to play the devil's advocate. If you find a prospective company very compelling, first start with rejecting the hypothesis. In other words, try to gather facts and arguments that will prove that the stock is a bad investment. After all your analysis, if you arrive at the conclusion that the stock is still good, then it has passed the bar. 

·                     You can also take a good lesson from the court of law. Law courts have processes and procedures in place that tend to minimise hasty and biased decision-making, which can cost someone's life. 

As investors, you must learn not to be hasty. Adjourn your stock purchases till you're not clear in your mind. 

Always remember, stock markets will always keep swinging higher and lower. Investing opportunities will be there. 

If you can tackle with your inconsistency-avoidance tendency, money will consistently keep pouring into your bank accounts. 

5.   Envy and Jealousy Tendency

These emotions are so innate to human nature that it is almost impossible to get rid of them.

Given the crucial role that these emotions play in the human world, you could risk ignoring them at your own peril. 

It is often said that stock markets are driven by greed and fear.

But legendary investor and Charlie Munger's 'Siamese twin,' Warren Buffett, has an important interruption to make here. He very wisely points out, "It is not greed that drives the world, but envy."

While 'greed' refers to an excessive desire to possess something, 'envy' is a desire to possess what the other person is possessing. 

And more often than not, greed is fuelled by envy.

Everyone is here not just to make money, but to make more money than what the next person is making. 

Comparison and competition is intense, creating a perfect recipe for jealousy tendency.

The important point to take home is to not let such negative emotions affect your investment decisions. 

But isn't it a little too difficult to not feel bad if your friends and colleagues make a lot more money than you do? It is indeed difficult. 

So the best antidote in such a case is to avoid discussions that would trigger feelings of jealousy.

In fact, some of the best investors in the world keep extremely low profile and keep their discussions limited to stock ideas and business fundamentals. 

In the absence of such external disturbances, they are able to make more rational investment decisions. 

6.   Over-optimism tendency 

Charlie Munger opines that an excess of optimism is the normal human condition. 

And this tendency to be over-optimistic not only manifests when man is in pain, but also when he is doing well and there is no threat of pain whatsoever.

"What a man wishes, that also will he believe." 

Over-optimism tendency drives not just stock markets but the entire world of finance and economics. 

Why otherwise would we have booms and bubbles with such amazing regularity?

Why do people continue to flock to the financial markets despite the regular crises and busts that torment the markets?

In fact, all the malaise troubling the global economy today, from the debt crises in the developed economies to the high inflation and slowing growth in emerging economies, do have roots in excessive optimism. 

The problem is that when things are good, we expect them to get better and better in a linear fashion. 

And even when things are bad and getting worse, we often expect that the situation will turn good again sometime in the future. 

This tendency is so often displayed by company managements. 

·                     During good times, they tend to get over-optimistic and take up massive debt-funded expansion plans by way of capacity additions or wasteful mergers and acquisitions. When the cycle turns and things turn sour, you see red ink all over their financial statements. 

·                     What is surprising is that even in bad times, a lot of companies are extremely shy to admit that things are not going too well. They tend to project and hope only what they wish to see and not what there is really. 

As investors, the best way to deal with this bias is to acknowledge that it exists in the first place. 

That is half solution done because most of the times we are not aware of our own biases. 

Then a very effective antidote to over-optimism is to challenge your views by asking yourself as many questions as possible. 

If your views cannot stand the attack of reason, you know which tendency is to be blamed. 

 7.  Social proof tendency

 What is social proof tendency? It is an automatic tendency to think and act the way people around you are thinking and acting. 

The social proof tendency works in both positive and negative situations.

Be it riots and terrorists. Or be it the massive support that came in for a certain good cause

This tendency most readily occurs in the presence of puzzlement or stress, or both. 

Charlie Munger points out one interesting aspect of the social proof tendency which very well explains why in certain societies, corruption is so deeply rooted. 

The "Serpico Syndrome" is named in the memory of Frank Serpico who once entered a highly corrupt New York police division. 

Unlike others, he resisted to be consumed by the contagion of corruption. And for that resistance, he was almost about to lose his life.

As it is evident, the evil of corruption continues to persist in our country because of this very Serpico Syndrome, which is created by the social proof tendency and the power of incentives. 

Akin to the other spheres of life, social proof tendency is present in overwhelming proportions in the world of business and finance.

It dominates how investors behave in stock markets, how company managements do business and so on.

Many of us may think of corporate leaders and managers as highly qualified, intelligent and experienced people who would be making rational business decisions.

A deadly force which Buffett calls the 'institutional imperative' often hinders rational decision making and at times, even destroys businesses. 

What does institutional imperative mean?  The Oracle of Omaha explains the institutional imperative as that need for managers to act and do like their peers no matter how irrational it may seem. 

A simpler term that comes to mind is peer pressure.

However surprising it may seem even CEOs are subject to this pressure which forces them to make stupid mistakes. 

'Everybody was doing that'. 

From his own mistakes, Buffett realised how important it was to not fall victim to this force. 

Have the management act as if they were the owners. What happens when managers start thinking like owners? They think very differently. They think twice if their own money is at stake. 

The tendency to fall prey to the social proof tendency is also seen among investors. 

Stock market booms, bubbles and eventual crashes clearly show how investors succumb to peer pressure and end up burning their fingers. 

What should investors do to avoid such mistakes? 

Buffett has a solution for this as well. He says, "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." 

It may sound simple but it's indeed a very powerful way to guard yourself against the social proof tendency. 

8.  Contrast Misreaction Tendency

How do we really perceive things? 

For instance, how does our brain figure that an elephant is a big fat creature? Or, how do we know that a tortoise is very slow? 

The answer to both these questions is relative comparison. 

We perceive everything in relative terms. 

This mode of perception extends to all things in life, and very evidently in investments and stock markets. 

It influences how we think about economic news and information, corporate performance, stock prices, and so on. 

The reason why we tend to perceive things in relative terms is that it is impossible for the human nervous system to measure everything in absolute scientific units. 

So we use our senses to identify things by comparing them with other things. 

It is the relative contrast that gives things their specific characteristics.

What is contrast misreaction tendency?  Contrast misreaction causes people to make wrong judgments based on misleading contrasts between two or more things and situations.

Charlie Munger cites an interesting example where this tendency is often misused-

A person is shifting to another city and looking for a new house for his family. 

To get some quick help, he goes to a real estate broker.

First, the salesman takes him around and shows him some really terrible homes for insanely high prices.

Then, he takes the person to a merely bad house at a slightly lower price. Need we mention what happens next!

What exactly went amiss in this case? How did the home buyer fall into the saleman's psychological trap? 

Blame it on the contrast misreaction tendency. 

When the person was shown the last property, he compared the house and its price to the horrible ones he saw before.

Because of this comparison, he was ready to buy the not-so-good-house at a pretty high price. 

Do investors in the stock markets also make wrong investment decisions because of the contrast misreaction tendency? The answer is yes, very often.

The following instance will explain how investors enter this psychological trap.

“Expensive at 140, attractive at 300!”

Mr C  was an active investor.

He was suggested by a friend to buy shares of XYZ Ltd when the stock price was 90 per share.

Instead of buying immediately, he decided to wait for some time.

But in just a matter of few weeks the stock price mounted to 140 per share. That was a whopping rise of nearly 56%.

Obviously, Mr C was very distressed. He cursed himself for not buying when the stock was trading at 90.

But now, he couldn't get himself to invest in the stock. It's way too expensive, he thought.

In the meanwhile, the stock continued to rally. In just a few months, the stock price was hovering around 400.

Mr C had never felt so miserable. 

He had missed such a big opportunity. 

But then the stock price faced some selling pressure and corrected by about 25%. 

At 300, what do you think Mr C must have done?  He invested heavily into the stock. 

Why did he not buy the stock at 140? What forced him to buy the same stock at 300? 

The answer in both cases is contrast misreaction tendency.

140 seemed very expensive in contrast to 90, the price at which his friend had suggested.

However, 300 seemed cheaper relative to the high of 400 that the stock had witnessed.

A similar mistake also occurs with valuation multiples. 

For instance, if a stock has commanded a price to earnings (P/E) multiple of 50 times in the past, it doesn't mean that a P/E of 30 times is a lucrative buying opportunity. 

How can investors avoid such thinking errors? 

The principles of value investing are a perfect antidote for the contrast misreaction tendency. 

Never judge the value of a company based on its past stock price performance or P/E multiples. 

Look at the company's business fundamentals and its past financial track record. 

How are the future growth prospects? 

What are the risks and opportunities to the business? 

Do the company's managers behave like owners? 

Valuing the company based on such important parameters will help you avoid false comparisons.

9.  Availability-misweighing tendency

What appears more often and more prominently around us assumes a lot more importance than it may deserve.

On the other hand, issues that may not be discussed could be disregarded as trivial. 

What does it mean? 

Charlie Munger explains it very aptly quoting a song: "When I'm not near the girl I love, I love the girl I'm near."

The human mind has a tendency to focus on what's easily available. And in doing so, often tends to give undue importance to it.

On the other hand, the significance of things and events that are not easily accessible could be undermined.

Business fundamentals and earnings drive stock prices over the long term. 

However, on a day-to-day basis, it is the relentless flow of news and information that sends markets up and down. 

Owing to this intricate relationship with news, the stock market is one place that most easily falls prey to the availability-misweighing tendency.

Isn't it often observed that news items that are prominently projected in the media elicit substantial response from the stock markets?

In other words, the markets are ready to react to any information that is made available to them. 

This also means that important matters that are not covered by the news media may be ignored by the stock markets. 

The case of individual investors is also very similar. 

Stocks that are most widely talked about in the media often make an easy entry into the stock portfolio.

Many companies tend to use this tendency to prop up their share prices. 

Using their PR machinery, companies bombard the media with press releases, interviews and news reports about every trivial development and achievement, many of which may not have any major impact on earnings. 

But in the absence of other relevant information, investors often end up giving undue importance to such insignificant matters. 

Charlie Munger suggests that taking Darwin's approach could be an effective antidote for availability-misweighing tendency. 

What did Darwin do to eliminate biases? 

It is said that Darwin was a very strong proponent of objectivity. He was known for playing the devil's advocate to his own ideas and hypotheses. 

So much so that as soon as he would have an idea, he would try to gather evidence to disconfirm it.

In fact, he tended to be even more rigorous in his approach with ideas that were particularly compelling.

Let's try and apply this approach to investing in stock markets. 

Say for instance, there is a certain stock that your friend has strongly recommended you to consider buying.

Suddenly, the stock price goes up following a positive piece of news. What would be your reaction? 

Your friend is optimistic about the stock. The news is positive. The markets too have cheered the news. Isn't there enough reason to run and call your broker to buy the shares?

If you would have done that, you would have quite likely fallen prey to the availability-misweighing tendency. 

A wiser response would have been to do what Darwin always did: Challenge the merit of the idea. 

Look for potential risks and concerns that could adversely affect the company.

Arrive at your independent view only after thoroughly evaluating the potential of the stock. 

The ultimate investing decision should be based solely on your understanding and insight and not from borrowed optimism. 

In short, if you come across a stock that appears to be the market's darling with a lot of media attention on it, play the devil's advocate and consider all possible risks and concerns that can derail the investment.

If the idea still holds, it is certainly worth investing.

It is observed that a vital quality that is common amongst all great investors is discipline. 

It is this discipline that helps them overcome the various thinking errors and biases, availability-misweighing tendency being one of them. 

A practical way to ensure discipline and to avoid falling prey to this tendency is to prepare an investment check list and adhere to the process in a disciplined manner. 

10.  Use-it-or-lose-it tendency

 If you don't use a certain skill, you tend to lose it gradually.

The same holds true for the various mental and physical skills that we possess. 

What can one do to avoid such loss of useful skills? The only way to keep such skills alive is to use them regularly.

The importance of regular practice is especially very vital in skills of a very higher order.

Charlie Munger suggests using something that is a functional equivalent of the aircraft simulator employed in pilot training. 

While investing is not a rocket science, there is no reason to take it too casually.

Many people take investing as a side business which can be done without putting in too much time and effort.   And that is one of the biggest fallacies. 

Legendary investors such as Warren Buffett, Charlie Munger and Peter Lynch did not create great fortunes out of thin air.

They are known to be rigorous practitioners of their art. 

They all read extensively and spend a huge amount of their daily routine analysing companies.

In other words, by using their mental skills meticulously, they have become successful pilots of the investing world. 

11.  Senescence-misinfluence tendency

Senescence-misinfluence refers to the cognitive decay and mental limitations on account of biological aging.

The aging process may differ from person to person in terms of the time it commences and the pace at which it progresses. 

But, by and large, old people have difficulty acquiring new skills. 

As such, the probability of learning complex new skills is practically zilch. 

Though acquiring new skills may be challenging,the good news is that some people very well manage to retain old skills that they have practiced intensely over the years.

What does senescence-misinfluence tendency have to do with investing?

Our financial needs change with the various phases of our life. 

Given that the topic under discussion concerns old age, let us focus on a person's financial needs post retirement. 

At this age, you may not have the burden of educating and marrying your kids.

You may also not have to worry about buying a home.

With all major investments and expenses behind you, you may be relatively relieved.

But you may have several other expenses. 

For instance, your healthcare expenses could be significantly higher.

You may also want to fulfil all the dreams that you may have sacrificed in your youth.  And so on. 

The point is that you are going to need a good deal of money irrespective of your age.

  

But would your pension income be enough to take care of your post-retirement needs? 

And wouldn't you want to avoid depending on your kids for money? 

At an age when you may not be in the best physical frame to travel distances and perform demanding tasks, what could you do for an alternative source of income? 

The answer is investing. 

Some may counter with the usual argument that investing in stocks is risky. 

Of course, there is no denying that there is an inherent risk. 

But the real risk of significant losses lies in speculative short-term trading.

If you choose the path of long term value investing, you will not only live with minimal risk, but the chances of immense profits will be significantly high.

Remember, in the long run, equities tend to outperform all major asset classes. 

But it would be a big mistake if you wait until retirement to start investing actively. The preparation has to start much earlier. 

When you are relatively young, invest time regularly to educate yourself about value investing.

Let this be a life-long process of learning and investing. 

In this way, you will be very well-equipped to deal with your investments in your latter years.

But wouldn't old age hinder your thinking abilities and decision making? 

Your greatest inspirations could be Warren Buffett (82 years) and his so-called Siamese twin Charlie Munger (89 years). 

What is the secret behind their outstanding thinking prowess and investing acumen even at this age? The answer is simple.

If you develop useful skills early in your life and practice them rigorously over the years, you could manage to retain those skills for a much longer period, despite the aging process. 

12.  Authority-misinfluence tendency

Why? Simply because it came from an authority! 

Errors owing to the misinfluence of authority are found across all spheres of human life. 

In some cases, the results tend to be very tragic.

A classic case that shows the powerful influence of an authority figure is the Holocaust. What else do you think could have motivated Nazis to ruthlessly slaughter millions of innocent Jews?

Why is man innately wired to follow authority?

What causes man to submissively bow down to authority even if it may seem wrong and unreasonable? 

The answer probably lies in the way we have evolved over the ages. All our ancestors lived in dominance hierarchies. 

Dominance hierarchy is a social living group with a ranking system based on power. 

Owing to competition over limited resources and mating opportunities, relative  relationships are developed between members of the same gender. 

This results in the creation of a social order. 

The social order undergoes changes only when a dominant animal is overpowered by a subordinate one.

Human societies have followed a similar path. 

History has been largely shaped by few men at the helm, while the majority of humanity has simply followed orders. 

This explains why following authority is a very automatic tendency of man. 

Following authority is not a flaw in itself. In several cases, it is quite crucial. 

For instance, think about the fate of a military operation where each member refuses to take orders without questioning. 

On the other hand, follow-the-leader tendency can be very dangerous at times as the examples above suggest.

Authority-Misinfluence tendency in stock markets

Uncertainty and risk have a big influence on how independently people take their decisions.

The greater the risk and uncertainty, the greater is the tendency to seek guidance and conformation from an authority figure. 

This makes the stock market a place that is incurably afflicted by the authority-misinfluence tendency.

Just spare a moment and ponder about how exactly you decide when to buy or sell a stock. 

Do you invest based on 'hot tips' shared by 'influential' friends?

Do you avidly track the portfolio of successful investors/ fund managers and try to mimic them?

Do you invest based on the advice given by stock experts who appear on television?

Do you blindly follow the advice of your broker or any other advisor?

If your answer is a 'yes' to any one of these, then here are some more questions. 

What makes you follow these experts? 

Do you ever question or challenge their opinions?

Do you trust them simply because they are in a position of authority?

Is it convenient for you to follow them blindly so that you can escape the blame in case things go wrong? 

If you honestly reflect over these questions you will see that your decisions are seldom your own.

In fact, it is not just small investors who fall prey to the wrong influence of authority.  Even experts do, a lot of times.

Listening to views and opinions from experts is quite valuable.

But there is difference between listening to experts with discretion and blindly following them. 

It is important that you exercise your own independent judgment to the opinions of others.


'Mr Market' is there to serve you, not to guide you

In an abstract sense, 'Mr Market' (as referred to the stock market by value investing genius Benjamin Graham) is a representation of an authority figure.

People pay excessive attention to where the markets are going.

But you must remember that 'Mr Market' is a fickle leader and often deviates away from the rational path.

The greatest investors in the world are those who do not give in to the moods of 'Mr Market'.

In fact, in his Letter to Shareholders in 1987, legendary investor Warren Buffett put down some very important lessons that he had learned from his Columbia Business School professor. 

Ben Graham had taught him to look at the market quotations as if they were coming from an emotionally troubled fellow called 'Mr Market'. 

The poor guy often goes through periods of euphoria followed by periods of gloom.

But the good thing is that 'Mr Market' does not mind if you ignore him.

His only job is to come up with a new quote every day, every few seconds.

So if you learn to command this peculiar gentleman, you can take advantage when he is gloomy and rack up great businesses at depressed prices. 

On the other hand, when 'Mr Market' is euphoric, you can simply ignore him. 

The most important thing to remember is to let the 'Mr Market' serve you, not to influence your investing decisions. 

13.  Twaddle tendency

All creatures survive in groups and the one factor that connects creatures of a species is communication.

One of the things that differentiate human beings from other animals is our ability to think. 

The relatively larger size of our cerebral cortex is the reason for our creativity, language and logical deduction.

As such, we have a highly advanced and complex language at our disposal.

But do we always make the most rational and productive use of words? The answer seems to be no.

And this is where the 'twaddle tendency' fits in. An online dictionary defines 'twaddle' as silly, trivial or pretentious talk or writing. 

Being a social animal, man often indulges in petty small talks and chatter. 

Twaddle or nonsense talks are not such a bad thing by themselves.

They only become a nuisance when they come in the way of some serious work that is in progress.  And this is what we need to keep a check on. 

Charlie Munger relates an interesting experiment on honeybees which can be used as an analogy to show how the twaddle tendency can lead to unproductive results.

After returning to the honey comb with pollen or nectar, the worker bee performs a dance with particular movements. 

The other worker bees then follow the directions suggested and set out to gather pollen and nectar.

A certain scientist was curious to know how the honeybees would respond if the nectar was placed in an unusual position.

So he placed the nectar in a straight-up position at a significant height.

As you would have guessed, no nectar exists in such a position in a natural setting.

So, this baffles the honeybee. It does not have a genetic program that is capable of communicating this new position. 

According to you, what should the honeybee ideally do in such a situation? 

It should just go back to the hive and pick a quiet corner, shouldn't it?   But the honeybee does not do that.

Instead, it comes back and attempts a dance.

But the dance turns out to be incoherent. Just like twaddle! 

Can this behavioural tendency of the honeybee also apply to human beings? 

Summary:

Do we behave to enviromental stimuli like ants?

1.  Reward and Punishment Super-response Tendency (Incentive and disincentive-caused bias)

2.  Liking and Loving Tendency (Fall in love and protect your capital, not with your stocks)

3. Doubt-avoidance Tendency (Quick conclusions and quick decisions are often preferred instead of the burden of doubts and ambiguity.  When neither under pressure nor threatened, a person should ideally not be prompted to remove doubt through rushing to some decision.)

4.  Inconsistency-avoidance Tendency (We tend to filter away any piece of information which may be inconsistent to our ideas and beliefs.  Be disciplined with your approach:  play the devil's advocate or have processes and procedures in place that tend to minimize hasty and biased decision making.  Adjourn your stock purchases till you are sure.  Stock markets will always keep swinging higher and lower.)

5.  Envy and Jealousy Tendency  (Greed is fuelled by envy.  Avoid discussions that would trigger feelings of jealousy.  Keep extremely low profile and keep discussions to stock ideas and business fundamentals.)

6.  Over-optimism tendency  (Excess of optimism is the normal human condition.  "What a man wishes, that also will he believe."  The best way is to acknowledge that this bias exists in the first place.  Challenge your views by asking yourself as many questions as possible to see if your views can stand the attack of reason.)

7.  Social proof tendency ( It is an automatic tendency to think and act the way people around you are thinking and acting.  The evil of corruption continues to persist because of the Serpico Syndrome, which is created by the social proof tendency and the power of incentives.  It dominates how investors behave in stock markets, how company managemetns (institutional imperative) do business and so on.  Have the management act as if they were the owners.  Buffett says, "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.)

8.  Contrast Misreaction Tendency  (We perceive everything in relative terms.  It influences how we think about economic news and information, corporate performance, stock prices and so on.  Contrast misreaction cause people to make wrong judgements based on misleading contrasts between two or more things and situations.  For example, a person shifting to another city and looking for a new house and his estate agent using this trick on him.  For the investor, why he did not buy the stock at 140 (because it rose from 90) and then he bought the same stock at 300 (because it fell from 450)?  A stock with P/E of 50 in past and is now at P/E of 30 does not mean it is a lucrative buying opportunity.  Look at the company's business fundamentals and its past financial track record.  Valuing the company based on such important parameters will help you avoid false comparisons.)

9.  Availability-misweighing Tendency  (Due to the relentless flow of news and information, the human mind has a tendency to focus on what's easily available.  In doing so, often tend to give undue importance to it.  In the absence of relevant information, investors often end up giving undue importance to such insignificant matters.  Adopt Charles Darwin's approach.  He would try to gather evidence to disconfirm it.  Challenge the merit of the idea.  Look for potential risks and concerns that could adversely affect the company.  The ultimate investing decision should be based solely on your understanding and insght and not from borrowed optimism.  Be discipline.  To avoid falling prey to this tendency is to prepare an investment check list and adhere to the process in a disciplined manner.)

10.  Use-it-or-lose-it Tendency  (The importance of regular practice is especially very vital in skills of a very higher order.  Many people take investing as a side business which can be done without putting in too much time and effort.  And that is one of the biggest fallacies.  Legendary investors such as Warren Buffett, Charlie Munger and Peter Lynch did not create great fortunes out of thin air. They are known to be rigorous practitioners of their art.  They all read extensively and spend a huge amount of their daily routine analysing companies.  By using their mental skills meticulously, they have become successful pilots of the investing world.)

11.  Senescence-misinfluence Tendency  (At an age when you may not be in the best physical frame to travel distances and perform demanding tasks, what could you do for an alternative source of income?  The answer is investing.  The real risk of significant losses lies in speculative short-term trading.  If you choose the path of long term value investing, you will not only live with minimal risk, but the chances of immense profits will be significantly high.  Remember, in the long run, equities tend to outperform all major asset classes.  If you develop useful skills early in your life and practice them rigorously over the years, you could manage to retain those skills for a much longer period, despite the aging process.)

12.  Authority-misinfluence Tendency  (Uncertainty and risk have a big influence on how independently people take their decisions.  This makes the stock market a place that is incurably afflicted by the authority-misinfluence tendency.  Just spare a moment and ponder about how exactly you decide when to buy or sell a stock.  What makes you follow these experts?  It is important that you exercise your own independent judgement to the opinions of others.  "Mr. Market is there to serve you, not to guide you."  The greatest investors in the world are those who do not give in to the moods of Mr. Market.  (Mr. Market is a parable told and popularised by Benjamin Graham, teacher of Warren Buffett.)

13.  Twaddle Tendency  (Man often indulges in petty small talks and chatter.  They only become a nuisance when they come in the way of some serious work that is in progress.  This twaddle tendency, like the twaddle dance of the honey bees, can lead to unproductive results.  And this is what we need to keep a check on.   Better to stay in a quiet corner meantime.)