Investing Psychology Chapter 1: The Illusion of Control (Part 2)
Continuing our deep dive into Chapter 1 of Tim Richards’ “Investing Psychology.” Last time, we talked about how our senses lie. Today, we’re looking at why we think we’re in charge when we definitely aren’t.
Uncertainty and “Unknown Unknowns”
Donald Rumsfeld famously talked about “unknown unknowns”—the stuff we don’t even know we don’t know.
Markets are full of this. But instead of admitting we’re clueless, we try to exert control. We develop “methods” that are basically just high-level superstitions. The best investors often just sit on their hands when things get weird. Sometimes, doing nothing is the smartest move you can make.
Stocks Aren’t Snakes
Our brains are wired for “fight or flight.” If we see something that looks like a snake, we jump. That’s a great survival trait.
But in the market, a “scary” stock isn’t a snake. You don’t need to make a split-second decision. In fact, most people who make fast decisions in the market end up losing money. Any broker who tells you that you “have to act now” is probably trying to use your ancient brain against you.
Following the Herd
When we’re confused, we look at what others are doing. It’s why we wait to see which fork someone else uses at a fancy dinner.
In investing, this is herding. We follow the “confident” people, even though they usually don’t have a clue either. If you’re buying a stock just because everyone on Twitter is talking about it, you’re officially part of the herd. And herds have a nasty habit of running off cliffs.
The Problem with Memory
We think our memory is like a video recording. It isn’t. It’s more like a Wikipedia page that anyone can edit.
We suffer from “false memory syndrome”—we “remember” being cautious before a crash when we were actually buying like crazy. We also focus on recent events (the recency effect) and ignore the long-term data.
The “Linda” Problem
There’s a famous puzzle about a woman named Linda. Based on a description of her, most people guess she’s a “feminist bank teller” rather than just a “bank teller.”
Mathematically, it’s impossible for a sub-category (feminist bank teller) to be more likely than the main category (bank teller). But we get distracted by the story. We ignore the base rates and go with what “feels” representative.
7 Key Takeaways from Chapter 1
- We’re all biased. Accept it and move on.
- Biases are unconscious. You can’t “think” them away; you need systems.
- Uncertainty makes it worse. Markets are unpredictable.
- You’re being exploited. The industry uses your biases to take your money.
- Experience isn’t enough. Your personal experience is too small a sample.
- Don’t hurry. Investment decisions are rarely time-critical.
- Use tools. Checklists and diaries beat gut feelings every time.
In Chapter 2, we’ll look at our own egos and why we think we’re all “above average.”