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Illusion of Knowledge and Illusion of Control

October 26, 2014 | About:

In his most famous talk “psychology human misjudgment,” Charlie Munger (Trades, Portfolio) warned us to be aware of the common human psychological biases that may do us enormous harm in life and investing. While this is a very good comprehensive list, I’ve personally added another two items on Munger’s list because I’ve found them almost ubiquitous in the investment world. You may find them overlapping with some of the concepts mentioned in Charlie’s talk. However, due to my perceive level of importance, I want to devote a whole article for these two biases – illusion of knowledge and illusion of control.

We all are subject to illusion of knowledge bias when we think we know more than we actually do. This, combined with the overconfidence bias, can make us think that our analysis is more accurate than what can be inferred from the information we have. One human tendency to deal with uncertainty is to collect as much information as possible. This tendency exacerbates the illusion of knowledge bias because as we collect more information, we tend to think we have better information and we know better than we otherwise would have had we not collected much information.

Illusion of knowledge often leads to the illusion of control, which is defined by Wikipedia as “the tendency for human beings to believe they can control or at least influence outcomes which they clearly cannot.” Or as James Montier of GMO put it, “the illusion of control refers to people’s believe that they have influence over the outcome of uncontrollable event.” In the investment world, this often translates to our illusion that we have control of the outcome of our investments when in reality, we don’t. This is especially the case when we collect a large amount of information. We may think we have all the available data and have reduced the risks in our future projections. However, our data may not be accurate and even if our data is accurate, it may be widely known by everybody who should and therefore, it is reflected in the stock price already.

Although it is perfectly painful to reflect on one of my worst mistakes in the past, sharing with the readers this particular mistake will likely to serve me well in that it reminds me of what went wrong and how could I improve in the future. More importantly, it is a good illustration of the illusion of knowledge and illusion of control bias. This mistake was my investment in Nokia a few years ago when iPhone and Android-based phones were taking over the smartphone world. As someone who has used Nokia’s phone since I was in high school (let’s throw in the liking bias and mere association bias here), I thought the drop in Nokia’s stock price was interesting. So what I did? I read Nokia’s annual reports from 2000 to 2011. I read a book about how Nokia went from a small company to a cellphone giant. I read articles on Nokia’s corporate culture. I visited AT-T and Microsoft stores to test out Nokia’s new Window’s phones. I gathered a lot of information on the number of apps on Windows mobile system and the market share of smartphones running the Windows system. I talked to people who were using Nokia’s smartphones. Heck, I even purchased a Nokia phone, which was another one of the worst investments I ever made. After all these information gathering, I felt pretty good about my knowledge on Nokia and the Windows mobile system. I was forecasting better future for Nokia than what turned out to be a bleak future. This ultimately led to my illusion of control – I thought I had some control over the outcome of my investment. After all, I had all the available data and I did so much work.

I won’t talk about how that investment ended up. Suffice is to say that it is not one that I am particularly proud of but it taught me good lessons. In the context of this article, it taught me that gathering more information does not equate to gaining knowledge and certainly that gathering more information and doing hard work do not give me an edge per se.

Some practical antidotes include seeking a second opinion and forcing yourself to write down and look back at your investment thesis. You can also ask questions such as who doesn’t know this and how confident I am with regards to the evidence. However, the ultimate antidote to those two biases, is to be aware of them first of all, and spend more time cultivating a better thinking and decision making process.

About the author:

A global value investor constantly seeking to acquire worldly wisdom. My investment philosophy has been inspired by Warren Buffett, Charlie Munger, Howard Marks, Chuck Akre, Li Lu, Zhang Lei and Peter Lynch.

Rating: 4.7/5 (14 votes)



ValueSense premium member - 6 years ago

Very well said. It is remarkable how all of our efforts to become more informed investors only lead us to strengthen our bias. All to often we find a stock that we love only to miss a competitor who is knocking their socks off.

Grahamites premium member - 6 years ago

Thank you Dave89joe. You have a great point, very often the more we are informed, the more biased we become. It is a great observation.

Belarophon - 6 years ago    Report SPAM

Good article. Nokia reminds me of one of my biggest weaknesses: Impatience. I sold them at around 1,40 € back in the middle of 2012 to limit the losses. I bought them a few months earlier at around 2 € because I thought that they won't go bankrupt and their patents might be a nice for a company like Microsoft. Their Lumia-smartphone was just being launched. (investment case: asset play/potential turnaround) Well - I guess you know how that all ended. Instead of 200 % plus I had around 30 % minus... But I think in many cases the painful lessons are often the best ones :-)

Argin32 - 6 years ago    Report SPAM

How much of what Nassim Taleb has been saying on the topic is of relevance? His whole focus on anti-knowledge and over confidence?

Also if this is true (what the article suggests) wouldn't that make investing as a whole useless since we really don't know or are not omniscient to all the facts?

At what point do we not have the illusion of knowledge and control?


Alphacashy - 6 years ago    Report SPAM

Great article. I made the same mistakes purchasing CarboCeramics in early 2012. I sought out information that supported why it was a great company and why it would prosper into the future(confirmation bias). I read heavily the propaganda put out by the company, supporting the use of ceramic. I ignored the fact that they abandoned plans to construct a distribution facility 20 miles from my home. I saw the signs but looked the other way. Now sand is the preferred proppant in the Bakken, the market knows this and has punished the shares accordingly. We need more articles like this so we can learn from each others mistakes. Thanks for sharing.

Seattle Ethan
Seattle Ethan - 6 years ago    Report SPAM

Another great article. Buffett says that he likes to find 2 foot poles to jump over. To me, fashion and technology are 9 foot poles. I don't think even most well informed investors (even without bias) can consistently pick winners since innovation brings constant changes.

I wonder if your level of research would have helped you pick the correct winner on hard liquor, beer, candies, ketchup maker, etc.

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