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Charlie Munger On Avoiding Anchoring Bias

By Rupert Hargreaves. Originally published at ValueWalk.

A recent update on an old idea by Charlie Munger with an emphasis on anchoring bias

Charlie Munger’s famous speech “The Psychology of Human Misjudgment” is thought to be one of the billionaire’s most intelligent and thought-provoking speeches on human psychology. For investors, the lessons in the speech are invaluable, and it is highly recommended reading for everyone who wants to succeed in the market.

Human Misjudgment is one of Munger’s best speeches, but it’s not the only informative speech on the topic of investing psychology. Danny Kahneman’s book Thinking, Fast & Slow is a highly acclaimed book on the topic.

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Charlie Munger

Philip Ordway, the principal and portfolio manager of Anabatic Fund, L.P., recently took on the challenge of combining these two texts, and filling in the gaps to help “improve my own understanding of the concepts by updating “The Psychology of Human Misjudgment” with more recent examples and case studies while also incorporating the related work of Kahneman, Tversky, and other prominent researchers.” This ‘best of’ compilation isn’t designed to “substitute or improve” the original works, but it does expand on the topics from a different viewpoint, igniting different ideas and conversations.

anchoring bias

Over the next few articles, I’m going to take a look at a few of the most interesting points made within Ordway’s text.

Avoiding Anchoring Bias

Anchoring is a cognitive bias that describes the common human tendency to rely too heavily on the first piece of information offered. Anchoring bias can be hugely damaging to an investors’ research process. Charlie Munger and Warren Buffett try at all costs to avoid anchoring, which can skew their investment opinion:

“We try and avoid the worst anchoring effect which is always your previous conclusion. We really try and destroy our previous ideas.” – Charlie Munger, 2016 Berkshire Hathaway annual meeting

Ordway points out that idea anchoring bias may be more likely for long duration research projects, as Danny Kahneman has previously described:

“When I work I have no sunk costs. I like changing my mind. Some people really don’t like it but for me changing my mind is a thrill. It’s an indication that I’m learning something. So I have no sunk costs in the sense that I can walk away from an idea that I’ve worked on for a year if I can see a better idea. It’s a good attitude for a researcher. The main track that young researchers fall into is sunk costs. They get to work on a project that doesn’t work and that is not promising but they keep at it. I think too much persistence can be bad for you in the intellectual world.” — Danny Kahneman

This, Ordway opines, is why investment conferences or public investment pitches may be a bad idea. Even though there are benefits to debating an idea in an open environment, the cost of anchoring may far outweigh the benefits. This isn’t just limited to institutional investors. Even private investors who post on message forums, write articles for the likes of Seeking Alpha or attend share clubs will be stuck with anchoring when they recommend a position. Trying to reverse course will be a lot harder as a result:

More money has probably been lost by investors holding a stock they really did not want until they could ‘at least come out even’ than from any other single reason.” – Phil Fisher, Common Stocks and Uncommon Profits

Investors can waste a lot of time and money being irrationally tied up to investment ideas and even political parties/investment managers. Ordway ponders, “how many political opinions or decisions would be different if not for commitment and consistency.” What’s more, how many asset managers “still have capital for the sole reason that they were previously given capital?

The modern world is full of tools to help the average investor get ahead, research companies and take on Wall Street. However, it’s also full of distractions such as second by second stock price updates, thousands of ideas on equities and low trading commissions, which encourage churn. Social media is another modern development that could hold back investors. Facebook and Twitter both lend themselves to the “what you’re shouting out your pounding in” idea:

“We know from the seminal work of Daniel Kahneman, author. Of “Thinking, Fast and Slow,” that when addressing a problem, the first thought that comes into our minds is often not the best answer we will ultimately arrive at. Our ‘fast’ brain comes up with its best approximation of the answer to a problem, but our ‘slow brain’ often has the last laugh. This raises the question of whether it makes sense to tweet…anything.” – Seth Klarman”

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Seth Klarman

The solution to removing these cognitive “issues” including but not only an anchoring bias is to attempt to keep your mind completely black. As Ordway notes “experts are amazingly adapt keeping their minds completely blank,” an open and flexible mind, one that is not pre-committed to one answer or idea is critical for making the best decisions and ensuring your process is not dominated by any biases’.

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