Why Professional Investors Need to Understand the Concept of Disavowal

Disavowal: Looking at the Psychology of Finance through a Psychoanalytic Lens

Second in a Series

What is Disavowal and Why Does It Matter?

Disavowal is a psychoanalytic term that describes a sneaky and pernicious defense mechanism that leads to very risky and foolish behavior. It is the fundamental mental flaw behind most white-collar crimes. Disavowal is one of the reasons people break their own well-thought out investing rules. Disavowal is the prime mover in the dumbest stuff you’re likely to do.

Everybody knows about disavowal’s cousin, denial, which is so familiar it’s a part of everyday vocabulary. Disavowal is not necessarily less common— and certainly not less dangerous— but it’s harder to understand, and that may be why you never heard of it before.

Disavowal is not Denial, But They’re Related

The easiest way to get at an understanding of disavowal is to understand the idea of denial, and then go through the looking glass to the crazy world of disavowal.

Denial is straightforward. Your mind rejects a fact, to avoid the pain that accepting it would cause. A problem drinker does not believe she has a drinking problem. A person with an illness does not accept that it has affected his performance.

With disavowal, facts are accepted as true, but bizarrely, they have no impact your behavior. It’s as if your mind has been split in two with a glass wall in between. On one side is logic, a bunch of reality based facts, and awareness of consequences. You see it all. You know it all. On the other side is “you”, who really wants to do something, often something risky. The reality and known dangers hanging on the far side of the wall are disconnected from emotion and your motivational system, and therefore fail to have an impact on the decisions you’re making. You go ahead and do the Really Dumb Thing.

You know when a famous person, let’s say a Congressman or Governor, gets caught doing something illegal, immoral or incredibly embarrassing? And they lose everything?

We think, incredulously, “You’re a smart person! How could you be so stupid to think you wouldn’t get caught?”

Intelligence, obviously, has nothing to do with it. Most likely, the individual in question knew the law, the risks, even the potential consequences. He probably wasn’t even thinking “the rules don’t apply to me.” He wasn’t thinking! Knowledge was split off from emotion and a subjective sense of reality. It just didn’t feel real, relevant, important, or worth paying attention even though a rational assessment would conclude that the consequences of ignoring reality could be dire.

AKA Willing Suspension of Disbelief

Famed investor Howard Marks, who understands the central role emotion plays in investing (especially as a source of mistakes!) borrowed the term “willing suspension of disbelief” from the world of theater to describe one of the key emotional gremlins that can lead the most experienced investor to do stupid things. Marks writes, “Many times over the course of my career, I’ve been amazed by how easy it is for people to engage in willing suspension of disbelief…people’s tendency to dismiss logic, history and time-honored norms.” (The Most Important Thing Illuminated)

I think what Marks is amazed at is the frequency with which people employ disavowal, which is the mental mechanism behind the “dismissal” of logic, etc. It’s not that we bury known facts (such as laws and rules and the consequences of breaking them) —disavowal sets up a situation where these facts and the logical conclusions that link them can’t gain any traction and therefore, weirdly, don’t impact our decisions.

Marks again: “Time and time again, the postmortems of financial debacles include two classic phrases: ‘It was too good to be true’ and “What were they thinking?’.”

Adaptive in Small Doses, Catastrophic in Large Ones

In small doses, disavowal is necessary for survival and essential for risk taking. Who would get in a car or airplane if the known reality of potential accidents had a strong emotional impact? We split off what we know about risks in life on an everyday basis in order to be able to do anything. What surgeon would start an operation if she really felt the reality of what she was about to do? No investor could tolerate any risk if he deeply felt the full impact of what could go wrong.

But in larger doses, or when it becomes an organized way of living life, disavowal is tremendously dangerous and a very hard habit to break.

What to do?

If it’s you?

Be vigilant.
Don’t assume you’re too smart to be so dumb.
Don’t assume it can’t happen again, because the inherent structure of disavowal, that “split”, is that it can and will.
Have a trusted partner who knows your vulnerability to disavowal—what realities are you tempted to disconnect from—and give them the power to stop you when you need to be stopped.

When it happens on your team

Teach the concept.
Be vigilant.
Take rapid action.
Don’t accept “It won’t happen again.”
Set alarms and fail-safes in place.
Assign a manager or coach specifically alert to this behavior to work with the investor.

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August 2017