Updated – 11/17/23

All humans have biases. It’s just in our DNA. That said, is there one more costly to us than an investment bias?

All investors are human beings, with biases.

So, there are many people who are subject to an investment bias of one kind or the other, and so there are many of us who need to hear this message.

In this post, we’ll cover just a few, shared by poker legend Annie Duke, split into these sections:

1. Decision Making in Uncertain Situations
2. An Example of Bias: Results Anchoring
3. Results Anchoring and Investing
4. How Investors Can Beat this Bias
5. Teaming Up to Beat Investment Biases
6. Echo Chamber Risks
7. A Takeaway for All of Us

Hopefully in learning about the biases that plague everyone, we can do better to become aware of and resist these biases, and keep their insidious effects at bay. And hopefully this will help us find better results with our money, and in our life.

Decision Making in Uncertain Situations

Annie Duke has a great pedigree in decision making and psychology. She is a World Series of Poker Champion, and finished her studies for a doctorate in cognitive psychology right before moving on to play poker professionally.

Poker is a great case study in decision making because, like in life, there are many uncertainties that are inherent when making these bets with real-life consequences.

In poker, like with investing and the stock market, good decisions don’t guarantee good results.

Improving can be difficult if we focus on results instead of decisions.

This was Annie Duke’s first great point in her national bestselling book, Thinking in Bets. I highly recommend reading this book if you want to improve as an investor, and especially if you want to learn about investment bias and how it can impact us all—especially the smarter that you are.

One of the many quotes I enjoyed about IQ and investment/ behavioral biases:

“Even research communities of highly intelligent and well-meaning individuals can fall prey to confirmation bias, as IQ is positively correlated with the number of reasons people find to support their own side in an argument”.

An Example of Bias: Results Anchoring

In a chapter called “Life is Poker, Not Chess”, Duke described the realities of life’s decisions that we must all face. Oftentimes our decisions require elements of uncertainty, and the results can be random. This makes life more like poker, where there is uncertainty and randomness, and less like chess, where each decision has strict rules and consequences.

Because of this uncertainty and randomness, sometimes we can make great decisions but achieve poor results, and vice versa.

As human beings, we tend to evaluate our decisions based on our results.

But this is a faulty bias and can plague investment results because sometimes the uncertainty of life simply leads to poor results despite great decision-making.

Of the many great examples of this phenomenon in the book, I loved the one about Pete Carroll’s influential play call during Super Bowl XLIX.

Faced with a decision that had the entire outcome of the game on the line, Carroll called a play that ended up losing the game for the team. Predictably, this decision—because it was slightly unorthodox—was lambasted by the media and “armchair quarterbacks” throughout the nation.

However, the probability was high that the decision was actually a good one.

Without getting too much into the specifics, there were still two more downs if the passing play went incomplete, and the previous odds of an interception at the goal line had been extremely low.

If Carroll’s Seahawks had won the game, and the decision had either worked for him or didn’t work to lose the game, this particular decision would’ve been a non-event.

However, because of the uncertainty of the result of the game, this particular decision stole the limelight as its outcome was what sealed the loss for the Seahawks.

This problem of tying the success of a decision to its results can make for very poor analysis and can be a significant source of investment bias in leading an investor to incorrectly evaluate his/her strategy, mindset, true skill level, and places to improve.

Results Anchoring and Investing

I’ll call it “results anchoring”. This inherent bias can be particularly troublesome if an investor gets lucky on a stock, and this lucky streak leads to overconfidence.

The fact of the matter is that stocks can rise astronomically for various reasons.

Some can be logical—Apple coming out with the groundbreaking iPhone makes sense to us…

But some are entirely illogical—traders loading up on a theme because it’s the day’s hot topic can be bewildering.

An investor who gets lucky on a stock (or stocks) will predictably repeat the previously successful process. Since the results depended on luck instead of actual skill, it’s highly unlikely that similar results can be duplicated without the same element of luck again.

Based on what we should all know about luck, relying on it as an investment strategy is not a great idea for our hard-earned savings.

You see this investment bias creep up, particularly with hot-shot fund managers.

The investing public loves to fixate on the fund managers with incredible returns over short periods of time and tends to overlook the managers who are pretty good but are achieving unexciting results.

This exact phenomenon creates massive inflows and then disappointments for many investors entrusting their money to these fund managers, as extreme outperformance tends to be due to luck (or higher risks taken) than anything else.

We see it time and time again, and it’s because like Vanessa Holden said:

“History doesn’t repeat itself; people do”.

How Investors Can Beat This Bias

The first step for us to fight this basic human tendency is to evaluate our previous decisions based on an objective basis rather than its outcome.

I fall victim to this bias more than anyone; I look across my portfolio and assume that the best performers must have been my best decisions.

But that’s not always necessarily the case.

Again, if you formulate a strategy based strictly on replicating your process on the winners, and reducing the types of investments like your losers, you could make detrimental changes to your portfolio over the long term.

Let’s say you bought two technology stocks at a time when tech becomes particularly favored in the market. Those two tech stocks would probably perform pretty well.

Seeing how much better these stocks are doing compared to the rest of your portfolio might compel you to buy more tech stocks.

If this causes you to pay too high of a price for these stocks, or significantly overweight your portfolio to become too exposed to a sector, you may pay the price of letting your previous success cripple your future results by attributing the wrong cause and effect, and then changing your behavior either subconsciously or not.

Because the stock market tends to weigh specific industries in-and-out of favor over time, this kind of mistake can be extremely painful when the trends change.

If there’s one thing to know about the stock market, it’s that it moves in cycles, and today’s expensive stock can become tomorrow’s cheap stock and vice versa.

Teaming Up to Beat Investment Biases

A great way to combat any investment bias that naturally occurs for all of us is to find outside people who can give you more subjective feedback.

Because we are inherently emotional, it’s easy to cloud our judgment with the narratives we form from our emotions. Results anchoring is a good example of this.

Another example that Annie Duke shared was the tendency for us to:

• Credit our skills when we get good results
• Excuse our poor results as being unlucky

And we also do the same thing, but in reverse:

• Credit others as lucky when they get good results
• Blame others for a lack of skill or judgement when they get poor results

Having an outside perspective, a fellow human being who falls victim to the same biases in evaluating ourselves and each other, might greatly help offset these tendencies and help us better evaluate our decision-making.

Duke credited her group of fellow poker professionals who provided her feedback as instrumental in her development into an eventual champion.

Finding an intentional group of experts with the same common goal, to evaluate their decisions without bias so that they could all improve worked well for Duke and can be applied by investors everywhere.

Echo Chamber Risks

However, there is a risk in assembling a team to analyze decision-making, and that’s in the echo chamber.

The echo chamber is a concept widely seen on the internet, as like-minded groups of people gather together and share similar ideas and ideologies. Confirming one’s beliefs connects people to each other and reinforces their beliefs.

The echo chamber as a bias can happen within the “truth-seeking” group that Duke describes, just as much as you might see online.

And it’s the same inherent human tendencies which create echo chambers online that create echo chambers among smaller and more intimate groups of people.

When you get down to it, human beings crave connection and affirmation. We have narratives of how we think the world works, shaped by our unique experiences, and we don’t like to see contradictory ideas that dismantle our narratives. This is only natural.

If an investor is really committed to shattering investment bias, and works to employ a team around them for better subjective ideas, then the creeping effect of an echo chamber also needs to be managed.

Ways to create the echo chamber, which should be avoided at all costs, include:

• Creating a homogenous group instead of a group with diverse opinions and backgrounds
• Quickly suppressing and dismissing ideas, which discourages future idea-sharing

In fact, Duke suggests that rational truth seekers should make a concerted effort to seek out contrarian views, and connect more (not less!) with people of opposing viewpoints to your own.

For sure, it’s not easy work because it goes against the grain of our natural selves.

But it could be immensely profitable and fulfilling, especially if it brings a new level of understanding and learning to spurn better results and wiser decisions over the long term.

A Takeaway for All of Us

Remember, many people are investors. And we are all flawed human beings.

A message like this is worth sharing to many people, since many of us will have one kind of investment bias or another.

Don’t be shy; share this message with another investor.

Doing that might also be a great way to find someone else to check your own investment biases, and find more rationality and better probabilities in your decisions.

We just scratched the surface with biases, decision-making, probability and uncertainty, and outcomes.

If this topic interests you greatly, may I suggest Annie Duke’s fantastic book, Thinking in Bets.

It’s amazing how much you can learn about investing, even from books that are not specifically tailored to talk about the stock market or specific strategies.

It goes back to the idea of attaining worldly wisdom, which the famous investor Charlie Munger has highly recommended for all investors in the stock market looking to improve.

Remember that the world is not as black-and-white as it may seem.

There are many uncertainties; the real world doesn’t align perfectly as we expect. Life and the markets are not a chess board.

Knowing these things, and becoming aware of other fundamental biases which we bring to our investments is a valuable skill for all of us to learn, and most of it is easily accessible through great books by experienced professionals like Annie Duke.

If you come across other great, insightful, and thought-provoking books like this—please, share them with us on Twitter so we can all benefit too.