Investing Psychology Chapter 6: How to Fix Your Brain (Part 1)
We’ve spent the last five chapters talking about how biased we are. Now it’s time for the “how-to” part. How do we actually fix these mental glitches?
In Chapter 6, Tim Richards gives us some bracing reality. There’s no “magic pill” for bias, but there are systems we can use to make ourselves slightly less stupid than the rest of the market.
Sweat the Numbers
The most boring answer is also the most effective: read the annual reports. Most investors don’t even look at the numbers; they just read the “narrative” at the beginning.
Managers use “self-serving bias” in their letters. When things go well, it’s because they’re geniuses. When things go bad, it’s “the economy.” Ignore the stories. Dig into the balance sheet. If a company has a solid cash pile, it can survive your own biased mistakes.
Contrarianism isn’t Free
Being a “contrarian” (doing the opposite of the herd) sounds smart, but it’s hard work. You can’t just buy every stock that goes down. That’s just “mean reversion” bias by another name.
Effective contrarianism means doing the research to find out why the market is wrong. Don’t just run against the herd blindly; you might just get trampled.
Short-Sellers are Your Friends
Short-sellers (people betting a stock will fall) are the least biased people in the market. Why? Because if they’re wrong, their losses are unlimited. They have to be sure of their numbers.
Before you buy a stock, check the “short interest.” If the pros are betting heavily against it, they probably know something you don’t. Don’t try to short stocks yourself (it’s a great way to lose your house), but use their research as a warning sign.
The Myth of “Diworsification”
There’s a common myth that you only need 15 stocks to be diversified. Richards says this is nonsense. 15 stocks might protect you if one company goes bust, but it won’t protect you if an entire sector collapses.
“Diworsification” is actually a debiasing technique. Spreading your money across different sectors, geographies, and asset classes is the only “free lunch” in investing. It prevents you from becoming too emotionally attached to one “winner.”
In the next post, we’ll talk about the “Wason Rule” and why you need to try and prove yourself wrong every single day.