Note: This article first appeared in the March 2015 issue of our premium newsletter, Value Investing Almanack .
Do you remember Dr. Placebo and Mr. Irrational?
They teamed up for our discussion on Mean Reversion , but kind of disappeared after that.
Although Mr. Irrational did come back for Contrast Mis-Reaction but Dr. Placebo, who runs a thriving practice, has been finding it hard to take out time from his busy schedule. So this time I made him an irresistible offer. Vishal and I offered him a discount on Value Investing Almanack subscription , which he just couldn’t refuse.
As far as Mr. Irrational is concerned, he’s my buddy, almost like my alter ego. So he has to come when I ask.
Let’s enter Dr. Placebo’s clinic. He has this very interesting quote, uttered by famous scientist Blaise Pascal, displayed in the patient waiting area –
All of humanity’s problems stem from man’s inability to sit quietly in a room alone.
He hopes that his waiting patients learn something from this deep thought, but little does he realize that more than his patients, he is the one who needs to meditate over Pascal’s quote.
By this time you probably are about to lose your patience. When am I going to stop beating around the bush and come to the point? Please hang in there and allow me to hold your attention for few more seconds. All that I have said above is quite related to our mental model for today which is – Do Something Bias .
In case it sounds too simple a name for a mental model, there is another term which I learnt from Nassim Taleb and it’s called ‘Naive Intervention’. If that sounds too jargon-ish then how about ADHD?
I am sure many of you know few friends who are so restless that they find it impossible to sit at one place quietly. They have very short attention span and can’t stay with one activity for long. In medical science this abnormality is known as ADHD (Attention Deficit Hyperactivity Disorder). What medical science doesn’t tell you explicitly is that evolution (yeah, the same process which transformed monkeys into humans) has installed the seeds of ADHD in every human brain.
Now in some cases this tendency is more pronounced and for few, with very severe symptoms of ADHD, may actually need medical treatment but for the rest of us this disorder manifests very subtly in our day to day decision making.
In an attempt to be efficient and productive we force ourselves to always stay busy with some task or other. Not being occupied gives the impression that we are incompetent and wasteful. But sometimes, quite often actually, too much activity becomes counterproductive. In psychology this flavour of ADHD is known as Do Something Bias (DSB).
19th Century American writer Henry David Thoreau said –
It is not enough to be busy; so are the ants. The question is: What are we busy about?’ Don’t confuse activity with results. There is no reason to do a good job with something you shouldn’t do in the first place.
DSB is not only wasteful but can harm you in the long term.
Ironically, even medical profession isn’t immune to the ill effects of DSB. In medical terms this is called iatrogenics , which means causing unintentional harm while trying to help.
Nassim Taleb has extensively discussed this topic in his book Antifragile . Here is an excerpt from the book –
Consider this need to do-something through an illustrative example. In the 1930s, 389 children were presented to New York City doctors; 174 of them were recommended tonsillectomies [surgically removing the tonsil, a small bell shaped piece of organ hanging inside your throat]. The remaining 215 children were again presented to doctors, and 99 were said to need the surgery. When the remaining 116 children were shown to yet a third set of doctors, 52 were recommended the surgery…note that a death occurs in about every 15000 such operations … every child who undergoes an unnecessary operation has a shortening of her life expectancy…
When you medicate a child for an imagined or invented psychiatric disease, say, ADHD or depression, instead of letting him out of the cage, the long-term harm is largely unaccounted for.
You can routinely find Dr. Placebo prescribing heavy doses of antibiotics for a minor seasonal cold. Most of these strong antibiotic drugs are hepatotoxic i.e. they have harmful effects on liver. In short them they expedite the recovery from flu but the liver damage isn’t visible immediately.
Why doesn’t he just send his patients back home with only an instruction to take rest and allow the body’s natural healing system to cure the minor cold? Taleb explains –
…the doctor who refrains from operating on a back (a very expensive surgery), instead giving it a chance to heal itself, will not be rewarded and judged as favourably as the doctor who makes the surgery look indispensable, then brings relief to the patient while exposing him to operating risks, while accruing great financial rewards to himself.
Obviously it’s not just the medical profession which is plagued with DSB. James Montier, in his book The Little Book Of Behavioral Investing , explains the prevalence of this psychological bias in the field of soccer.
During penalty kicks, 94% or the times the goal keepers either dive towards their left or towards their right. However, if they stay at the center their success rate is far higher. Explanation offered by these goalkeepers was that at least they feel they are making an effort when they dive left or right, whereas standing in the center and watching a goal scored to the left or the right of you would feel much worse.
The idea of DSB originates from the human urge to say “Look what I did for you” than “Look what I avoided for you”. This is closely related to the concept of silent evidence that we discussed in the Behaviouronomics section of first issue of Value Investing Almanack (you don’t need to subscribe to VIA, the first issue is freely downloadable).
My fears came true when I prodded Dr. Placebo little more about this –
Anshul: Doctor, don’t you know that most of these flu cases don’t need medical intervention? And these strong doses of antibiotics that you prescribe have long term harmful effects.
Dr. Placebo: Yes Anshul, you’re right. But if I don’t prescribe any medicine to my patients they feel I haven’t done anything to help them. Why would they pay a hefty fee for doing nothing? Moreover, prescribing these medicines have psychological effect also. Just because they are popping a pill makes them believe that they are getting better. Placebo effect you know! (smiling sheepishly)
Anshul: In that case you could actually prescribe them placebos. You don’t need to stuff them with toxic drugs.
Dr. Placebo: People are smart these days. Even before buying the drug they pull out their smart phones and google about the drug. If they find that I am prescribing them simple placebos they might stop coming to me or worse they might even file a malpractice lawsuit against me. Can you see my predicament?
Even though this is an imagined conversation, Dr. Placebo has a point here. Just like the Soccer situation, this is a classic lollapalooza created by incentive caused bias (also called agency problem) and DSB. In case you haven’t heard of the term lollapalooza, you must read Poor Charlie’s Almanack .
One of the culprits for triggering DSB in human mind is the overload of information. Has it ever happened that you opened the front page of the leading financial newspaper and it said “Nothing significant happened today”. For that matter majority of news (financial or non-financial) is toxic. You don’t believe me? Check out this article by Rolf Dobelli, author of bestselling book The Art of Thinking Clearly .
In Business and Investing
Let’s turn to the field of finance and see how this behavioural model explains certain peculiarities present in the markets.
The market ups and downs are natural economic cycles (very similar to a living organism whose pulse is not a straight line) and it’s the natural way of maintaining a dynamic equilibrium (supply and demand). Any human intervention (faulty government policies to bail out failing banks or printing excess money) to iron out these natural cycles only seems to help in the short run. In the long run these actions actually build up a bigger bubble and results in severe devastating markets crashes.
Any small fluctuation in the markets/economies creates an urge in policy maker’s mind to do something about it. This itch to DSB (instead of giving market some time to self-correct itself) creates unintended consequences by blowing up the severity of original boom and bust cycles.
Short term fluctuations in the stock prices is a noise that you are supposed to ignore. If you start reacting to every small portfolio fluctuations and churn your portfolio frequently, in the long run your performance will be poor.
Another interesting property of DSB is that the urge to act tends to intensify after a loss (a period of poor portfolio performance). So if your portfolio hasn’t performed well for sometime (short term), it’s very difficult to sit and do nothing about it. This is when you need to be alert and be aware of your vulnerability.
Similarly, if you have cash but no opportunity available (a common problem for value investors during bull market), you need to practice patience and remind yourself of ill effects of DSB.
Warren Buffett says –
Holding cash is uncomfortable, but not as uncomfortable as doing something stupid.
This video aptly captures the idea –
Making too many decisions also introduces something called decision fatigue. The more decisions you have to make lower the quality of each decision. Too many decisions and over activity increase the odds of failure especially in stock market investing.
How To Overcome
So how do you deal with this bias ? The cure for this irrational behaviour is patience. Let’s look at a role model in the field of professional sports (after all we are aiming to become multidisciplinary thinkers) who has successfully overcome this behavioural bias.
Even if you aren’t a big cricket fan you must be familiar with Rahul Dravid and his batting style. He is known to be the most patient batsman. Instead of swinging his bat at every ball he would patiently wait for the right one, a ball which is well inside his circle of competence (remember those perfectly executed cover drives).
That’s what made him one of the most consistent batsman in cricket history. Scoring 5 double centuries in test cricket isn’t a joke. It won’t be an overstatement if I say that Dravid’s record is akin to compounding money at 25 percent CAGR for 25 years.
So what does it mean for you when it comes to stock market investing? Does it mean that you should close your eyes and stop looking for ideas?
Not really. It definitely doesn’t mean that you should stop reading annual reports .
It means that instead of trying to score a six on every ball, if you can patiently wait for the right stock to appear at the right price, you too can become “the wall” in stock market investing.
I know sitting on the sidetracks and waiting is very boring but I hope you understand that investing is a serious game and it’s purpose is not entertainment. As legendary investor Seth Klarman puts it:
In a world in which most investors appear interested in figuring out how to make money every second and chase the idea du jour, there ’s also something validating about the message that it’s okay to do nothing and wait for opportunities to present themselves or to pay off. That’s lonely and contrary a lot of the time, but reminding yourself that that ’s what it takes is quite helpful.
What it means is that while making any decision or taking any action, you should be aware of your vulnerability for DSB. You should question yourself whether your decision is backed by sound reasons and analysis or it is just an excuse to satisfy the itch to do something.
S. Pulavarti, who manages the $ 1.5 billion UCLA endowment fund says –
I believe in making as few decision as possible. It’s like you are in jungle with a gun which has only 5 bullets. If you are told that there is tiger in the jungle, you will be very careful about when to pull the trigger. It’s the same with investments.
I will close this discussion with a quote from Warren Buffett –
I could improve your ultimate financial welfare by giving you a ticket with only twenty slots in it so that you had twenty punches – representing all the investments that you got to make in a lifetime. And once you’d punched through the card, you couldn’t make any more investments at all. Under those rules, you’d really think carefully about what you did, and you’d be forced to load up on what you’d really thought about. So you’d do so much better.
Take care and keep learning.
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