One of the most important tools that we can have as investors is the ability to challenge our own ideas and conclusions. We live in an ever-changing world and to think that our conclusions should be excluded from this phenomenon is a little naïve.
One of Charlie Munger (Trades, Portfolio)'s most celebrated and recommended books is "Influence: The Psychology of Persuasion" by Robert Cialdini. While the book covers and expands on six biases, I want to touch on one of the hardest to deal with from the list: consistency bias.
Consistency bias is the psychological tendency that we have to avoid disconfirming evidence to what we have already said or done. To avoid mental fatigue and the pain of admitting our errors, we stick to our arguments in spite of information that could (and should) affect that conclusion. The hard part of dealing with this is the humility to accept that one could be wrong and to keep the ego at bay, which generally loves to have it right all the time.
Naturally, as the exposure of any given person becomes greater, the commitment to one's views becomes even stronger. One great example of consistency bias is Bill Ackman (Trades, Portfolio) and Valeant (VRX, Financial). In spite of new financial information arriving, the stock price reacting to that information and a big controversy emerging, my hypothesis is that Ackman fell victim to his own previous success and comments. This is proof that we are all prone to error and that even extremely bright people can suffer from this bias.
Seth Klarman (Trades, Portfolio) has previously mentioned that being an investor implies an interesting paradox. On one hand, we need to have a certain degree of arrogance to say, whether buying or selling, that the other side of the trade is wrong, and we are going to make some money based on our idea. However, on the other hand we need to have a strong degree of humility to say "I could be wrong" and the other side of the trade might know something we don't. Provided that investing is a zero-sum game, this paradox will be forever relevant.
In his book, Cialdini recommends that for us to reduce the consistency bias effects, we should recognize when we are being forced into decisions that we would not or do not want to make. While the author recognizes that this is not easy to do, it helps us realize we are in an uncomfortable place. When we acknowledge this uncomfortable place, the best thing to do is to step back and ponder the pros and cons rationally. Going back to the Valeant case, there was a great deal of information that needed to be incorporated to update the investment thesis that was just overlooked to save some face in public. To his credit, Ackman has publicly recognized he made a mistake investing in Valeant.
Cialdini's analysis and Klarman's statement about the balance between arrogance and humility suggest we should be less prone to blinding ourselves by optimism or pesimism.
What do you think?
Disclosure: I currently have no positions in VRX nor intent to do so.
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