Investing

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Latticework of Mental Models: Cognitive Dissonance

I am sure many of you have heard the famous Aesop’s fable about the fox and the grapes. If not, here’s a quick recap of the story.

A fox sees some high-hanging grapes and wishes to eat them. When it is unable to think of a way to reach them, it decides that the grapes are not worth eating. The fox then justifies that the grapes are not ripe or they are sour (hence the common phrase ‘sour grapes’).

Every time I hear this story, I laugh at the delusional fox. However, I rarely imagine that a similar fox is inside me also. The fable is a classic illustration of what psychologists call Cognitive Dissonance.

Behavioural scientists define cognitive dissonance as the feeling of mental discomfort or tension produced by the combined presence of two thoughts, ideas, beliefs, attitudes, or opinions that are psychologically inconsistent. The greater the discomfort, the greater the desire to reduce the dissonance of the two cognitive elements. Dissonance theory suggests that if individuals act in ways that contradict their beliefs, then they typically will change their beliefs to align with their actions.

In case of Aesop’s fox, an inconsistency arose when the fox set out to do something and failed to accomplish it. He could resolve this conflict in one of three ways: (a) by somehow getting at the grapes, (b) by admitting that his skills are insufficient, or (c) by reinterpreting what happened retrospectively. The last option is an example of cognitive dissonance, or, rather, its resolution.

The cognitive dissonance theory was developed in 1957 by Leon Festinger, who observed in a series of experiments that people would change their attitudes to make them more consistent with actions they had just taken. Cognitive dissonance is one of many behavioural biases that evolution has wired into the human brain.

When Long-Term Thinking is a Terrible Idea

During my evening walk yesterday, I was with a 75-year old gentleman who seemed fitter than I am, walked faster than me, had a wider smile than I can ever manage, and talked much more than I do in a few days.

During the ninety minutes we walked together, we talked about our lives, careers, and investing.

“What do you do for a living, young man?” he asked me.

“I am a blogger and an investor,” I replied.

“What kind of an investor are you?” he asked back.

“Well, a long term investor in the stock market,” I said.

“Long term? Great! Even I have been a long term investor all my life,” he told me. “Long term investing makes a lot of sense.”

“Yeah it does,” I said. “Having a long-term thinking is always good.”

“Well, not always, son!” he replied.

“Why do you say so?” I asked.

Latticework of Mental Models: Economies of Scale

“Do we have flexible working hours here?” That was the first question I asked when I joined my first job in IT industry.

“Yes. As long as you get your 40 hours in at the end of every week.” Informed my new boss.

That was a great deal considering the previous 9-hours-6-day job I had in a manufacturing industry. Forty-hour week was even better than the schedule I had during my school days.

In India the culture of forty-hour week became more popular with growth of IT industry. Have you ever wondered how this idea of forty-hour week came to be?

The credit for our 8-hour-5-day work week goes to an unsuspecting guy called Henry Ford, the founder of Ford Motor Company.

Until 1900 most industries used to have 100-hour work weeks. But in 1914, Ford Motor Company took the radical step of cutting the work-shift duration to eight hours. This was an unconventional move in those times but when this change saw an increase in Ford’s productivity, other companies followed suit and soon the 8-hour-day became the norm.

But the question is, how did the productivity increase with reduction in work hours?

A Powerful Tool to Create Your Stock Watchlist

Whether you’re training for a marathon or going on an adventure trip, being ready can make a world of difference.

The same is true for the stock market. It’s important to be prepared with a watchlist of fundamentally sound stocks ready to go at right prices.

Whether the market is in rally mode or in a correction, being prepared with a watchlist is key.

Here is a video I’ve prepared to help you learn a simple yet powerful tool of creating your own stock watchlist, which is dynamic and tells you in a snap the status of stocks you are watching.

If you can’t see the video above, click here to see.

Let me know your thoughts on the video, and also share any other way(s) you maintain your own stock watchlist.

Resources:
1. Sample Stock Watchlist
2. Google Spreadsheets Help Center

P.S. This post was originally published in Dec. 2013, and has been republished following a lot of reader questions on this topic.

Latticework of Mental Models: Bayes Theorem

A statistics professor who travels a lot was concerned about the possibility of a bomb onboard his plane. He determined the probability of this and found it to be low but not low enough for him. So now he always travels with a bomb in his suitcase. He reasons that the probability of two bombs being onboard would be infinitesimal.

Do you think he has really reduced the risk?

Even those who aren’t well versed with the basic concepts of probability can say that the professor’s logic seems absurd.

Well, the bomb riddle is a famous joke among mathematicians. Nevertheless, it’s a thought provoking joke.

So to help you think about the riddle, let’s explore another related thought experiment.

A man wakes up in the middle of the night with a splitting headache. He remembers that there are few aspirin bottles in the bathroom. He dizzily stumbles into his bathroom to grab one of the four bottles in the dark and pops a pill from that bottle. An hour later, instead of getting relief from headache, he starts feeling a terrible nausea. Suddenly he realizes that only three of the four bottles in the bathroom contained aspirin and the fourth bottle contained poison.

8 Big Ideas from a Super Investor: Philip Fisher

Note: This article formed part of the April 2015 Special Report sent to subscribers of our premium newsletter Value Investing Almanack.

If you are a Warren Buffett fan, chances are slim that you haven’t heard of Philip Fisher. He belongs to the league of those very few super investors who have shaped Buffett’s investing style.

In his 2013 letter to investors, Buffett ranked Fisher’s book next to Ben Graham’s books –

…Phil Fisher put it wonderfully 54 years ago in Chapter 7 of his Common Stocks and Uncommon Profits, a book that ranks behind only The Intelligent Investor and the 1940 edition of Security Analysis in the all-time-best list for the serious investor.

Despite being considered as a super investor, Philip Fisher was little known to general public and rarely interviewed. He is widely respected and admired in the value investing circles all over the world. He is also known for his ‘scuttlebutt’ approach, which simply means seeking information from competitors, customers, and suppliers, all of whom have a vested interest in the company.

He wasn’t among those who made decisions just by reading annual reports. He believed in getting first hand information about the company from various sources.

Now, when it comes to following an advice, it’s more sensible to first take up the recommendation about “what NOT to do” instead of “what to do”. So, in the spirit of inversion, let me explore some of the don’ts in investing recommended by Fisher through his various interviews and writings.

Latticework of Mental Models: Winner’s Curse

Consider this thought experiment –

A friend of yours is the Chairman of the Acme Oil Company. He occasionally calls with a problem and asks your advice. This time the problem is about bidding in an auction. It seems another oil company has gone into bankruptcy and is forced to sell off some of the land it has acquired for future oil exploration. There is one plot Acme is interested. Until recently, it was expected that only three firms would bid for the plot, and Acme intended to bid $10 million. Now they have learned that seven more firms are bidding, bringing the total to ten. The question is, should Acme increase or decrease its bid? What advice would you give?

Do you advise bidding more or less?

If you’re like me and seeing this case study for the first time you’d probably go with a higher bid. After all, there are additional bidders, and if you don’t bid more you won’t get this land. Isn’t it?

Latticework of Mental Models: Pari-mutuel System

You don’t win by predicting the future; you win by getting the odds right. You can be right about the future and still not make any money. ~ Will Bonner

The way to win in stock market, according to Charlie Munger, is to work, work, work, work and hope to have a few insights.

Now, the question is – how many insights do you need in your investing lifetime?

Not many, as Munger says…

…you don’t need many in a lifetime. If you look at Berkshire Hathaway and all of its accumulated billions, the top ten insights account for most of it. And that’s with a very brilliant man—Warren’s a lot more able than I am and very disciplined—devoting his lifetime to it. I don’t mean to say that he’s only had ten insights. I’m just saying, that most of the money came from ten insights.

So you can get very remarkable investment results if you think more like a winning pari-mutuel player. Just think of it as a heavy odds against game full of craziness with an occasional mispriced something or other. And you’re probably not going to be smart enough to find thousands in a lifetime. And when you get a few, you really load up. It’s just that simple.

Munger uses horse racing’s Pari-mutuel betting system as one of his mental models to make sense of stock market investing. He is asking us to think like a Pari-mutuel player and look for the mispriced bets.

So what’s a Pari-mutuel system and how does one find a mispriced bet in such a system?

An Investor’s Best Friend

In one of his most dramatic investment outlooks yet, Bill Gross wrote in May 2015 about fears of his looming death –

Having turned the corner on my 70th year, like prize winning author Julian Barnes, I have a sense of an ending. Death frightens me and causes what Barnes calls great unrest, but for me it is not death but the dying that does so . . .

What I fear most is the dying . . . the suffering that . . .will accompany most of us along that downward sloping glide path filled with cancer, stroke, and associated surgeries which make life less bearable than it was a day, a month, a decade before.

He then went on to relate this to the coming death of the investment super-cycle the world over.

Latticework of Mental Models: Loser’s Game

In the hope of executing an impressive smash, I again sent the ball flying away from the table. Losing yet another game of table tennis to Navin, a good friend and a colleague in my previous job. It was probably 50th consecutive loss since I started playing TT with Navin.

“It isn’t that I am an extraordinary player,” explained Navin, “I just focus on returning the ball back on your side. Your unforced errors are just too many so you continue to lose.”

The idea of unforced error didn’t make much sense to me at that time. And the streak of losses continued for another few months until our employer decided to remove the TT facility from the office. They reasoned that some employees were spending more time on TT table than their workstation. I wonder who those employees were. 😉

It took another few years for the idea of ‘unforced errors’ to sink in properly. It happened when I learned about a concept called – Loser’s Game.