Success in investing relies on controlling emotional urges, like herd mentality, rather than high intelligence. Buffett's famous quote and his actions during the dot-com bubble illustrate that emotional discipline is the key differentiator for great investors.
To overcome emotional biases in painful decisions, imagine a close friend is in your exact situation and ask what advice you would give them. This creates distance, allowing for a more rational, observer's perspective, free from the emotional baggage clouding your own judgment.
In situations like investing, where stakes are high but control is limited, humans invent compelling narratives they want to believe. Morgan Housel calls these "appealing fictions," which can lead investors to ignore reality and make poor decisions based on comforting stories.
Known as "resulting," this bias makes it impossible to evaluate decisions fairly. We may deem a choice poor simply because it led to a loss, even if the process was sound. This prevents learning from probabilistic events and encourages chasing lucky outcomes instead of repeatable strategies.
To fight overconfidence before a big decision, conduct a "premortem." Imagine the investment has already failed spectacularly and work backward to list all the plausible reasons for its failure. This exercise forces engagement of your analytical "System 2" brain, revealing risks your optimistic side would ignore.
When faced with a difficult question (e.g., calculating intrinsic value), our mind substitutes it with an easier one (e.g., "Do I like this company's story?"). This mental shortcut, detailed by Kahneman, leads to significant judgment errors in investing by prioritizing feeling over analysis.
Nassim Taleb's "narrative fallacy" describes how we construct overly simple stories about the past. Focusing on Google's successful decisions exaggerates the founders' skill while ignoring the critical role of luck and the countless other companies that failed despite similar strategies.
During the Constellation Software sell-off, even bullish institutional investors sold their positions. The reason wasn't a change in fundamentals but rather pressure to follow short-term momentum and appease shareholders. This behavior, driven by career risk, creates opportunities for investors focused on long-term business value.
The current market price acts as a powerful cognitive anchor. A high or rising price makes us subconsciously look for reasons to justify it, making an overvalued stock feel like a good buy. Conversely, a falling price anchors our thinking to negative narratives, making an undervalued stock feel inherently risky.
Kahneman's research reveals a critical asymmetry: we prefer a sure gain over a probable larger one, but we'll accept a probable larger loss to avoid a sure smaller one. This explains why investors often sell winning stocks too early ("locking in gains") and hold onto losing stocks for too long ("hoping to get back to even").