I was reading a book called Nudge by Thaler & Sunstein. The book is essentially about how we as humans are not as inherently wired as we think we are to think logically and rationally even when we have all the facts in front of us. There was a very interesting chapter that caught my attention as it relates to investing.
Let me explain: Thaler & Sunstein explain that humans are endowed with two systems of thought that characterize the way we think and ineveitably these two systems pinball back and foward and disfigure are sense of what we think is logicality, when in fact it is not. You see, as humans, we have our “Automatic System” which is what it basically means; thoughts that are instinctual and automatic precipitated by certain situations for example, thinking panic in the surprise moment of air plane turbulance. The other sytem is our ”Reflective” thinking pattent. This is the type of thinking you would use mapping out your strategy in a chess game.
Our cognitive process is a bi-part stream built off these two polarities. What results is many cognitive biases that affects our decisions in life. Often times, we “feel” that we are thinking logically, when the resulting action in and of itself suggests quite the opposite. This is wonderfully illustrated by what is known as “Anchoring.” Essentially, when humans rely more heavily on one particular parcel of information more so than others to figure something out.
Ie., A resident of Chigago is asked to figure out the population of Milawaukee. Knowing that Milawaukee is a big city, but not the size of the metropolis that Chicago is. That resident would “anchor” on the statistic of Chicago’s population of 3 million (because it’s what he knows first) and divide it by 1/3rd and arrive at the answer of 1,000,000. Whereas, say, a resident of Green Bay – a smaller city in relation to Milawaukee would anchor up from the population of Green Bay of 100,000 and triple it to arrive at the answer of 300,000.
They’re both wrong! The real population of Milawaukee is over 580,000!
It just goes to show you, how leaning too heavily on a certain fact can lead you off on to an inaccurate path of valuation! One can see how easily this bias easily applies to the process of investing when we first look at the price and create the architecture of our judgement on that set of information. I know I have been guilty of that myself.
Even Warren Buffett says that if he looks at the price, it will affect his judgement as to what he thinks the company is worth. Makes perfect sense!
Again, the book is called Nudge. It’s pretty cool!
Carson for Stockrip.com<---Ask a CEO a question and they resond via video!
Let me explain: Thaler & Sunstein explain that humans are endowed with two systems of thought that characterize the way we think and ineveitably these two systems pinball back and foward and disfigure are sense of what we think is logicality, when in fact it is not. You see, as humans, we have our “Automatic System” which is what it basically means; thoughts that are instinctual and automatic precipitated by certain situations for example, thinking panic in the surprise moment of air plane turbulance. The other sytem is our ”Reflective” thinking pattent. This is the type of thinking you would use mapping out your strategy in a chess game.
Our cognitive process is a bi-part stream built off these two polarities. What results is many cognitive biases that affects our decisions in life. Often times, we “feel” that we are thinking logically, when the resulting action in and of itself suggests quite the opposite. This is wonderfully illustrated by what is known as “Anchoring.” Essentially, when humans rely more heavily on one particular parcel of information more so than others to figure something out.
Ie., A resident of Chigago is asked to figure out the population of Milawaukee. Knowing that Milawaukee is a big city, but not the size of the metropolis that Chicago is. That resident would “anchor” on the statistic of Chicago’s population of 3 million (because it’s what he knows first) and divide it by 1/3rd and arrive at the answer of 1,000,000. Whereas, say, a resident of Green Bay – a smaller city in relation to Milawaukee would anchor up from the population of Green Bay of 100,000 and triple it to arrive at the answer of 300,000.
They’re both wrong! The real population of Milawaukee is over 580,000!
It just goes to show you, how leaning too heavily on a certain fact can lead you off on to an inaccurate path of valuation! One can see how easily this bias easily applies to the process of investing when we first look at the price and create the architecture of our judgement on that set of information. I know I have been guilty of that myself.
Even Warren Buffett says that if he looks at the price, it will affect his judgement as to what he thinks the company is worth. Makes perfect sense!
Again, the book is called Nudge. It’s pretty cool!
Carson for Stockrip.com<---Ask a CEO a question and they resond via video!
