Tag: psychology of investing

  • Self-Reflection – An Essential Analytical Skill with a  Brief How-to Guide  for Professional Investors

    Self-Reflection – An Essential Analytical Skill with a Brief How-to Guide for Professional Investors

    Self-reflection:  Looking at the Psychology of Finance Through a Psychoanalytic Lens

    Fifth in a Series

    Self-awareness has tangible business benefits.  It allows you to know your what your blind spots are, what triggers an emotional over-reaction, what makes you risk too little or too much, what psychological state you’re in and what the implications of that are and when you’re fatigued or not functioning at your best. All these psychological elements can distort your assessment of a situation and deform your decision-making process. Self-awareness also allows you to know how you’re perceived by others, an essential aspect of every successful negotiation.

    While self-knowledge [i]comes more easily to some than others, there is a distinct, definable analytical process that leads to it—self-reflection.  Just like investors develop analytical skills to interpret activity and anomalies in the market, learning and practicing self-analytic techniques can help you develop a greater sensitivity to patterns, trends, and anomalies in your psychic state.  Self-reflection needs to be an ongoing mental process, operating most of the time in the background. It isn’t something you do on a fifteen-minute meditative break.

    Reflection and insight are the foundations of psychoanalysis. They are teachable skills that can be learned and honed over time.  Here is a how-to guide to get you started on penetrating the less accessible aspects of your own mental life.

    Practice these techniques:

    1. Practice turning your mental gaze inward and start asking yourself questions. What just happened? What am I feeling? What am I thinking?  Why did I do that?
    2. Try to let your mind loose—ask a question but don’t force an answer. Let a question like “What’s going on with me?” hover and see what comes to your mind.  Avoid quickly foreclosing on an answer because the first  answer is usually not the complete one.  See if images, memories or thoughts pop up in your mind.  If you are able to visualize your mind as a space, check the corners and out-of-the way spots to see if anything is lurking there in the shadows.
    3. Don’t rush to a conclusion. Always ask “What else could it mean/be/signify?”  “What else might have happened?”  Ask “If this conclusion is wrong, what could be the answer?”  Try reversing your assumption.  For example, if you think “I felt anxious because my manager was mad at me”, try reversing it to “I am anxious because I’m mad at my manager” and consider whether that feels right.
    4. Think associatively rather than in a linear manner. That’s how our emotional minds work.  One thought or feeling is linked to another in an ever expanding and deepening network.  Put something—an event– in the center of your mind—let’s say you broke one of your investing rules with bad results— and see what comes to your mind in relation to it. “I felt bored, and didn’t feel like waiting”.  Or “I was pissed that my numbers were bad and I just wanted a win”.    Do you remember Magic 8 Balls, where an answer would float to the surface?  It’s kind of like that.  Rather than the logical analysis we’re trained in, this is an exercise that allows different parts of your mind to make themselves heard.
    5. When you’ve hit on an important and “true” insight it’s likely to connect with a thunk— “Oh yeah that’s it.” There should be a mild physical and emotional response that is absent with other hypotheses.
    6. Once you think you’ve got something figured out (e.g. “I’m anxious because I’m angry”) go a step further. Ask yourself why that made you mad.  Repeat the process of letting your mind loose (see #2).  Rather than jumping to an answer, let your mind go and see what comes into it.
    7. Keep going to more and more layers. Start with the insight “I’m anxious because I’m angry”.  Then it occurs to you, “I’m angry because I was humiliated”.  Good progress.  Then, ask “Why was I humiliated to that intense degree?” Now you realize, “I was humiliated because I’m always extremely sensitive to exposure of a vulnerability”.  Now you’ve got a useful piece of self-awareness you can work with.  You know you can’t stand people seeing you as vulnerable, so you tend to overreact, become enraged; that makes you uncomfortable so you become anxious.  Once you’ve gotten this far, it’s much easier to accept the feeling and control your reaction.  You know, now, you hate being exposed as vulnerable, you’ll always be sensitive to that, but you’ll survive. This awareness gives you a chance to think before acting on your emotional reactivity.  What really does the damage is the anger, anxiety and consequent impulsivity, not the fundamental emotional sensitivity.
    8. Pay attention to sequences. Event>emotion>thought>emotion>action.  Or emotion>action>emotion>event. Knowledge about your personal repetitive thought/emotion/behavior patterns is extremely useful because it gives you the ability to interrupt a destructive sequence. To get a handle on habitual sequences, start with an action you regret, like breaking an investing rule.  Ask yourself what happened before that.  “I had a conversation with R, another PM, and he got me feeling competitive.  I wanted something to happen fast”. If you can identify that as a repetitive pattern, you can be vigilant, knowing that a conversation that makes you feel like you’re failing the competition is likely to lead to riskier bets.  Alert to that, you can block action-consequences the next time you meet R in the hall and he makes you feel small.  You’re basically substituting thought, in the form of self-awareness (understanding your emotional reactions) for impulsive action. The paradigm is “When I’m in this typical situation, I respond with this typical emotion which can lead to that typical action”.
    9. Learn about different broad-stroke states you experience over time. Many investors cycle through periods of elation/ excitement/optimism and pessimism/deflation.  Your mood cycles may or may not coincide with the market’s.  Recognize what emotional state you are in, and know it won’t last forever.  While you are in a given state, your thinking may be different.  The cognitive biases you are prey to may not be the same when you are in an elated, excited state as when you are in a pessimistic state of mind.  Learn how you think and make decisions in each different emotional state.
    10. Accept that you are not rational. No one is.  The point is not to make sense of your feelings or thoughts, but to get to know them.

    copyright September 2017

    Invantage Advising

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    [i] I am using self-awareness and self-knowledge interchangeable.  Take your pick.  Self-reflection is the means to that end.

    More Posts in this series:

    For Professional Investors:  A Couple of Things You Should Know About Anxiety

    For Professional Investors:  Why You Won’t Follow Your Own Rules and What to Do About It

    Why Professional Investors Need to Understand the Concept of Disavowal

    Why Professional Investors Need to Understand the Concept of Regression

  • For Professional Investors:  A Couple of Things You Should Know about Anxiety

    For Professional Investors: A Couple of Things You Should Know about Anxiety

    Anxiety:  Looking at the Psychology of Finance Through a Psychoanalytic Lens

    Fourth in a Series

     

    Anxiety is ubiquitous. It serves an essential function—alerting us to danger, to the need to reassess the environment, to act.

    It is a both  physical and emotional. Anxiety is a state of biological arousal that is actively communicating something to you: “Wake up, pay attention, get out of danger”.

    As with all other psychological phenomena I describe in this series, you can’t avoid anxiety—to do so would be akin to being a person who doesn’t experience pain, and is therefore very vulnerable to injury.  But by understanding it, knowing your personal anxiety-related idiosyncrasies, and learning to listen to and manage anxiety you can both use it and also avoid falling prey to mistakes anxiety can contribute to.

    Anxiety disorders develop when anxiety gets way out of hand, taking on a life of its own.  There’s often a genetic contribution to these mental health conditions that include panic disorder and OCD.  But in this post, I’m talking about “normal” anxiety that rises in everyone and anyone under certain conditions—and it can be pretty intense and still normal.

    Intense anxiety bordering on panic is incredibly uncomfortable.  Most of us will do anything we can to avoid it or stop it.  There’s nothing inherently wrong with this strategy, unless the avoidance-thing-you-do becomes a habit or leads you to ignore important incoming data.

    In moderate doses anxiety is alerting.  In large doses, it is disorganizing.  So, in addition to recognizing anxiety and it’s sources, you need to learn to assess your level of anxiety and act accordingly.

    Although we talk about different types of anxiety, the subjective experience is a final common pathway for multiple triggers or sources.

    In this post, I’m going to describe four kinds of anxiety that might be under your radar.  This is not meant to be an exhaustive list.  But these are some variations of anxiety that I think you should know about:

    Annihilation anxiety-Psychoanalysts consider this the most primitive and disorganizing kind of anxiety.  “Annihilation” refers to psychological, not physical undoing.  Under sway of this type of anxiety, you feel that you can’t get ahold of yourself, or you’re falling apart, or you’re losing your grip.  Things can feel unreal and fractured. The circumstances where this kind of anxiety might occur include emotional overload or an extreme amount of change or disruption, dislocation, or loss of customary supports.  Even positive events can be overwhelming in this way.

    Annihilation anxiety tends to be non-specific, so even with skillful introspection you’re not going to come up with a distinct cause or solvable problems. Consider this report from John D. Rockefeller, Sr., looking back on his early years building Standard Oil:

    “For years on end I never had a solid night’s sleep, worrying about how it was to come out…I tossed about in bed night after night worrying over the outcome…All the fortune that I have made has not served to compensate for the anxiety of that period”. (quoted in Titan, Ron Chernow, p. 122).

    A few things are striking about the Rockefeller quote. Notice that his anxiety is diffuse. He’s not worrying about this contract or that refinery, but, vaguely, “how it was to come out”.  And the intensity and pain of his anxiety is clear from the fact that it is still so vivid decades later, as well as in his statement that all his subsequent riches don’t make up for it.

    Annihilation anxiety’s primary value is to tell you that you are overwhelmed.  It doesn’t signal specific problems to solve.

    Narcissistic anxiety—I’ve never met a single person who doesn’t hate feeling humiliated, exposed or shamed.  Anxiety comes in to this picture in two ways.  First, each of us has a different threshold of tolerance for these experiences.  If you’re a person with a thin skin who is easily humiliated or often feels exposed, you’re likely to have chronic anxiety worrying that this very uncomfortable experience is about to occur.  This anticipatory anxiety can skew your decision making. The second entry point for narcissistic anxiety comes after you are embarrassed/humiliated/exposed by something dumb you did.  If you’re overly aware of or sensitive to what people might think, you’re going to lose focus worrying about how they are viewing you rather than collecting yourself and getting back to work.

    Traumatic anxiety- Here, I’m talking about real but not overwhelming traumatic experiences.  Trauma states occur when events override your customary coping mechanisms. We are vulnerable to traumatic states when events are unprecedented, unpredicted, unfamiliar, sudden.  During the height of Hurricane Harvey, the National Weather Service tweeted: “This event is unprecedented & all impacts are unknown & beyond anything experienced”.  To me, the NWS description of this level of uncertainty meant the forecasters there were subject to traumatic levels of anxiety, not to mention 1st responders and emergency managers.

    Idiosyncratic Anxiety –anxiety reactions that are unique to you. Some things are going to make you anxious that don’t make other people anxious.  I’m not talking about something clear-cut, like you are afraid of flying and others are not, but a subtler pattern of reactivity that stems from your individual temperament and psychological history.  Let’s say everyone acknowledges that the market is over-valued; prices are too high but they are still going up.  Your colleagues are on the boat still making money on the rising tide.  You’ve done well too, but have a much stronger urge than your peers to get out of your long bets before your stocks’ value has peaked.  The excitement seems crazy to you and makes you very, very nervous. The over-excited market correctly makes you anxious, sending a useful signal that this can’t last.  But your anxiety response may be a shade too strong if you especially can’t stand this kind of irrationality and you’re apt to pull the plug too soon.  Remember, anxiety is always a useful signal.  But you need to make sure that you don’t over-react or under-react to it.

    What you can do

    As with every psychology factor that can effect investment decisions, information and self-knowledge is the most important remedy.  Understand and accept that anxiety is normal and inevitable.

    See my blog post on self-reflection for some insights on building insight and self-awareness.

    If your anxiety has the characteristics of annihilation anxiety, the best immediate antidote is to do something concrete and manageable with a definable endpoint. Update your charts or your trading journal.  Organize your desk or your sticky notes. Cling to your routines and habits.  Don’t make decisions until you can think more clearly.  Get something to eat, drink a bottle of water, go to the gym.

    When your anxiety is related to humiliation or exposure, try a conversation with yourself.  Acknowledge that you hate the feeling of humiliation because, well, it’s just plain awful—but remind yourself you’ll survive.   Then look at your decisions carefully and see if any are being swayed by a desire to avoid being humiliated.  The point isn’t to get rid of the feeling, because you can’t, at least not in the short run.  The goal is to avoid compounding the problem by letting it lead you to bad financial decisions.  In the end, it’s better to make a good investment decision and risk being embarrassed than to make a bad one in a probably futile effort to avoid humiliation.

    Get to know yourself better so you are intimately acquainted with your idiosyncratic sources of anxiety.  Look carefully at how these patterns of emotional reactivity might be systematically tilting your investment decisions.  Add rules to your trading program to prevent yourself from making systematic anxiety-based errors.  Read more on the psychology of trading rules and why you will inevitably break them in this related post.

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    copyright September 2017

    Invantage Advising

    Other posts in this series:

    For Professional Investors:  Why You Won’t Follow Your Own Rules and What to Do About It

    Why Professional Investors Need to Understand the Concept of Disavowal

    Why Professional Investors Need to Understand the Concept of Regression

  • The Market Has Its Head Seriously in the Sand

    The Market Has Its Head Seriously in the Sand

    Article Posted on Linked-In Today

    As a psychoanalyst, I’ve been perplexed and amazed that the market has been on such a steady upswing, with the VIX, the well-known “fear index”, hitting record lows on July 26. And, CNBC reminded us, “Even before Wednesday’s move, the VIX had steadily fallen to lows not seen in more than two decades amid U.S. stocks’ steady climb higher”

    A prolonged period of placid growth has coincided with the most tumultuous, bizarre and unpredictable time in a half century of American history.

    Chuck Todd on MSNBC said tonight, “the Stock market went bonkers today” over reports that Gary Cohn might be leaving his position as President Trump’s Chief Economic Advisor. “Who will run the economy?” Todd asked rhetorically.

    I’ve been expecting the stock market to go bonkers every day since 9:00 pm on November 8, 2016. I told my clients to count on nothing but instability and craziness. I was wrong, but I shouldn’t have been. The market should have been afraid, because absolutely nothing was predictable, ordinary or similar to anything we’ve ever encountered in politics in America.

    How has anyone on Wall Street thought anything was stable or safe? That any person could be relied on to stay in the Trump administration? That Trump’s promised agenda regarding taxes and infrastructure was gong to sail through Congress? Apparently they wanted it to be true so they acted as if it was.

    I can only account for this by offering up for your consideration a psychoanalytic concept called “disavowal”. I described this defense mechanism in a recent blog post “Why Professional Investors Need to Know About the Concept of Disavowal”. I was writing about the necessity of knowing about disavowal for all investors at all times, not particularly focussed on this one strange moment in time.

    Here’s how I introduced disavowal:

    Disavowal is a psychoanalytic term that describes a sneaky and pernicious defense mechanism that leads to very risky 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.

    With disavowal, facts are accepted as true, but bizarrely, they have no impact on your decisions. It’s as if your mind has been split in two with a glass wall in between. On one side is a bunch of reality based facts, logic and awareness of consequences. You see it all. You know it all. On the other side is “you”, who really wants to do something, or believe something. 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. 

    In the last 10 months, the Really Dumb Thing has been not being afraid.

    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. In The Most Important Thing Illuminated, 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.”

    At a point in history where there is no history to use as a comparison point, when there are no norms, one would think that market fear would be at an all time high. I suggest disavowal is responsible for the fact that it’s not. Wall Street has stubbornly not wanted to know what it had to know. It was more exciting to think about corporate tax rates dropping, of forthcoming private contracts for huge infrastructure projects, or about a businessman, finally, in the White House, or of favorable trade deals.

    On the other side of that glass wall that people erect when they are employing disavowal were a lot of known but ignored facts–that Donald Trump was an unknown, that he was unpredictable, that the populist/authoritarian appeal that propelled him into office was an enormous threat to the basic American institutions that corporate America depends on. With disavowal, knowledge is split off from emotion and a subjective sense of reality. It just doesn’t feel real, relevant, important, or worth paying attention to despite the fact that a rational assessment would conclude that the consequences of ignoring reality could be dire.

    In the world of psychology, the employment of extreme disavowal has predictable consequences. There comes a moment of catastrophic reckoning, when reality catches up with the decisions that were made while ignoring it.

    copyright 2017 Invantage Advising

  • For Professional Investors:  Why you won’t follow your own rules and What to do about it

    For Professional Investors:  Why you won’t follow your own rules and What to do about it

    Rule-Breaking:  Looking at the Psychology of Finance through a Psychoanalytic Lens

    Third in a Series

    Introduction

    Experienced investors believe in the importance of rules.  Rules that specify entry and exit triggers, acceptable volatility ranges, trade size parameters and so on. They organize their rules into trading plans and systems, the uniqueness of which gives them their edge. But except for someone who surrenders control entirely to a computer algorithm, there comes a moment when even the most experienced investor breaks one of his own rules.

    This post uses a psychoanalytic lens to explain why it is inevitable that you will break your own rules and how to  decrease the frequency and minimize damage.

    The Inevitability of Breaking Rules

    Rule breaking is often attributed to lack of consistency, discipline and/or confidence. (for example Crist and Dennis).

    This diagnosis is subtly moralistic.  If you break rules, you obviously lack discipline or confidence—the implication is you’re “bad” or “weak”. Besides being unhelpful, this viewpoint also ignores human nature and the inevitable power of emotion.

    So why do people, including those who are quite confident and disciplined, regularly and inevitably break their own rules? And this despite the pain that usually follows?

    Investment guru Howard Marks is closer to the cause with his focus on emotion:

    “Most people are driven by greed, fear, envy and other emotions that render objectivity impossible and open the door for significant mistakes” (The Most Important Thing Illuminated).

    Reasons for Rule Breaking[i]

    Temperament

    Temperament is your innate way of behaving and reacting, a stable way of perceiving and responding to the world.  Temperament and personal history effect decision making (and therefore rule breaking).  The variations are endless, but here are two common patterns:

    • Stimulus-seeking. Following rules is boring.  You wouldn’t be in this business if you liked doing things in a predictable, rule-bound way. Rule breaking can come from a drive to pursue excitement in the form of daring bets.  And inhibiting yourself can be irksome to the point of fomenting rebellion.
    • Market observers describe states of cyclical euphoria and despondency.  If your temperament includes a component of what psychiatrists call “cyclothymia” —mood variability that alternates between excited, energetic, overly optimistic highs and depleted, pessimistic lows– it’s likely that you will be extra-sensitive to the market’s mood swings which may resonate with and amplify your own. In an elevated mood state, people are universally more impulsive and risk taking.  In a down cycle, people are pessimistic and slow to make decisions.  These overall affective states can be powerful and could easily tip you into the temptation to break one of your rules.

    Group Psychology, aka Jumping on the Bandwagon

    This danger has been widely noted[ii] yet humans being humans, people keep jumping. This is not surprising, since we have evolved to be social creatures.  Our DNA whispers to most of us “stick with the crowd if you want to survive”.  The feelings and thinking of the group exert a magnetic, biologically based pull to match your thoughts and emotions with the herd. Especially if your rules dictate a position that is contrary to the larger group’s prevailing attitude and behavior, you’re likely to experience increasing internal tension. No one enjoys feeling left out of a party, or out on a limb when everyone else is retreating. You start to wonder, maybe everyone knows something you don’t know. The temptation to break your rules grows as your own positions depart from the herd’s.

    What about contrarians?  They are certainly less susceptible –though not entirely immune—to the pressure to join the herd. However, if you are a hard-boiled contrarian you can even rebel against rules you’ve placed voluntarily on your own trading.  I’m a contrarian myself so I’m sympathetic to this position.  If someone tells me I can’t do something I feel a nearly irresistible urge to do it.  If I tell myself I can’t do something, I just as strongly want to say, “oh yeah, just watch me.”

    Emotional forces

    Emotional forces are more fluid and tend to occur in reaction to specific experiences.  While cognitive biases have garnered most of the attention in discussions of the psychology of investing, a smart handful of people have warned about the power of emotion (Once again, see Marks, Buffet, Tuckett[ii] ) . Relevant emotional forces include those that are ubiquitous—everyone experiences them at some time or another–and those that are idiosyncratic-part of your unique makeup and perception/reaction system.

            Ubiquitous emotions

    Investment guru Howard Marks identifies a quiver of emotions and emotional forces that affect every investor:  greed, fear, tendency to conform to the view of the herd, envy and “ego”.  I would add the wish to avoid shame and humiliation. Any powerful emotion can lead you to rationalize departure from your system and rules.  Especially if you are unaware of them, emotions can always override rational thought and considered discipline.

            Idiosyncratic emotions

    Getting acquainted with emotional reaction patterns unique to you requires some practice in self-reflection.  Each of us has triggers for emotional reactions that are idiosyncratic and sometimes counterintuitive.  For one person, boredom becomes a nearly intolerable itch to act and make something happen. Another is hypersensitive to competition with sibling substitutes. Still another person reacts paradoxically to success.

    “Disavowal”

    This is a sneaky and pernicious psychological defense mechanism that everyone is vulnerable to and all investors should know about. It’s complicated, so I explain it in depth in a separate post.  Briefly, it’s a mental disconnect–the strange capacity of the mind to know something very clearly but act in a way that defies the implications of that knowledge.

     What can you do?

    Howard Marks: “What, in the end, are investors to do about these psychological urges that push them toward doing foolish things…Learn to see them for what they are…Be realistic—you’re not immune to these forces” [iv].

    His prescription? “Although we will always feel them [emotions], we must not succumb; rather, we must recognize them for what they are and stand against them.  Reason must overcome emotion. [emphasis added]”

    Marks’ prescription reminds me of Bob Newhart’s famous line as a TV psychotherapist faced with a patient’s irrational fear: “Stop it”.

    If only we could stop ourselves from being driven by emotion.  The Stoics tried it centuries ago, and I suppose a few people can pull it off. But for the clear majority of humans it’s important to understand you are beset by irrational emotional forces AND you can’t just will yourself stoically to resist them.

    Acceptance and Humility

    As Marks correctly insists, know you are as susceptible to these forces as the next person.

    Practice Self Awareness

    You need to learn how the forces of temperament and emotions –both ubiquitous and idiosyncratic– apply to you personally.The key operation in gaining self-awareness is looking at sequences.  Investors are used to doing this in analyzing the market.

    You start with a critical event—you broke a rule, made a mistake– and work backwards.  What mental state were you in before?  What emotions can you identify that preceded your action?  And what came before that spike in emotion?

    If you do this after-action analysis for every instance of rule-breaking, you’ll start to see typical patterns that will clue you into your personal, unique tilts, triggers and vulnerabilities. Take a look at my blog post on “Why professional investors need to know about the concept of psychological regression” which alerts you to some predictable situations that make rational behavior less accessible. Once you know when you are more susceptible to breaking your investing rules, you can set up extra stop-gaps and alerts to try to get you to think before acting when you’re in a similar frame of mind in the future.

    Make Two New Rules

    # 1 WAIT.  Hopefully, you now believe there will be times you want to depart from your system.  Try to put a wait time in place.  Even a 30-minute pause can give you a chance to reconsider your impulse and remember why you have a system in the first place.

    #2 TALK TO A DESIGNATED HUMAN BEING BEFORE YOU BREAK YOUR RULES.  Choose someone to be your external braking system.  The rule is you must get in touch with them before you break a rule or deviate from your system.  If you can’t reach them, you can’t make the trade.  You’re not asking for their permission; you’re just telling them you’re going to break your own rule and you’re willing to listen to their reaction.

    **

    What’s to stop you from this breaking these rules?  Well, you could do that too.  Then it’s time to ask yourself why you might be sabotaging your own success.  Meanwhile, I also suggest a goal of diminishing the frequency and impact of rule breaking, rather than eliminating it entirely.  Your best defense is to know yourself in as much depth as possible and be realistic about and alert to the ubiquity and power of emotional forces.

     

    [i] You might notice I’m not including cognitive biases, which are well known in the industry, as one of the causes of rule breaking. Disciplined following of a set of rules ought, theoretically at least, to eliminate the effect of cognitive biases such as loss aversion, confirmation bias, disposition effect etc.  So, departures from rules can’t be explained by the usual concepts from behavioral finance.

    [ii] See, for example, Howard Marks, The Most Important Thing Illuminated, David Tuckett, Minding the Markets, and Warren Buffett, The Essays of Warren Buffett

    [iv] Howard Marks, The Most Important Thing Illuminated

     

     

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    Copyright: Invantage Advising

    August 2017

     

     

     

     

  • Why Professional Investors Need to Understand the Concept of Disavowal

    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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    Copyright: Invantage Advising

    August 2017