Illusion of Control

– Meghashyam Sinkar

Have you observed or seen anyone trying to make the call or to type the message while driving the car ? Or drinking and driving ? So, that person believes that he can control the car if anything comes in front of his car suddenly and hence he continues to do this activity with the belief that he is in full control of his future action or outcome . We underestimate risk because we are in possession of all the facts and we feel that we can control the situation when in reality we can’t.

This is called Illusion of control Bias .

Rolf Dobelli , in his book – “The Art of Thinking Clearly” shares the nice instance

Every day, shortly before nine o’clock in the morning, a man with a red hat stands at a busy traffic light and begins to wave his cap frantically. After five minutes he disappears.

One day, a policeman comes up to him and asks: “Sir! May I ask what you are doing?”

“I’m keeping the giraffes away,” replies the man.

The puzzled policeman looks around and tells him, “But there aren’t any giraffes here.”

“Well, I must be doing a good job, then.” says the man proudly.

You may conclude that the man with the red hat wasn’t in the good of his mental health. However , The man’s belief, that absence of evidence (giraffes) is a proof of his prowess in controlling giraffe traffic, is the result of a behavioural bias called Illusion of Control.

The illusion of control bias describes the tendency of humans to believe that they can control or at least influence outcomes when, in fact, they cannot.

Almost 50 years ago, a group of 3 behavioural scientists conducted an experiment. They asked people to place bets on calling the right number from a roll of dice. The dice was rolled by the persons placing the bets. For a few turns, the dice would be rolled, the outcome hidden, and the participant would be asked to place his bet on the outcome. For some other turns, participants would be asked to first place their bets, and then roll the dice. Bets could be of varied amounts each time. After gathering findings from a number of participants, for a number of attempts, the researchers found a clear pattern emerging. Bet sizes tended to be much lower when placed after the dice was rolled, and much larger when placed before the dice was rolled. Participants obviously believed in their own ability to somehow influence the outcome – which is why they were willing to place bigger bets before the dice was rolled, but much smaller bets after they had rolled the dice. A classic case of illusion of control.

Ten years after this experiment, another experiment was conducted, by a different team. Individuals were sold $1 lottery tickets. Half the participants were sold tickets that were randomly picked and given to them, while the other half were allowed to pick a ticket of their choice, after looking at number sequences and so on. A week later, on the day of the draw, just before the draw, each participant was asked to quote a price at which they were willing to sell their ticket. The average selling price asked by the group that was given randomly selected tickets, was $ 1.96. The corresponding number for the group that was allowed to pick tickets of their own choice, was considerably higher, at $ 8.67. Here again, those who picked their own tickets, had an illusion that they had higher control on the outcome, which is why their asking price for their tickets was much higher.

When you add money decision with this illusion of control bias then it becomes toxic combination . Illusion of control is often observed in stock investing, when investors who do a lot of hard work before picking up stocks believe that their hard analysis and knowledge gives them control over the future of stocks they own. If the stock price corrects then they buy more of it with the concept of averaging it out which is certainly not bad . However, sometimes investors exceed the desired weightage in stock or sector or particular asset class . 

Benjamin Graham , in his book “The Intelligent Investor” writes – 

“The only thing you can be confident of while forecasting further stock returns is that you will probably turn out to be wrong . The only indisputable truth that the past teaches us is that future will always surprise us – always !”

Individual investors don’t diversify their stock portfolio properly with defined framework. Their concentration keeps increasing if any particular stock is added with some insightful information with detailed analysis and they keep tracking it closing . The fact that they are doing things themselves give them the illusion that they know what’s happening .

Equity Traders who watch the markets quite frequently , follow all the market related information -domestic & global , always try to remain on the top of it and then apply their own analysis to take the stock position believe that they have an edge and can immediately control the situation if needed . But , Mr. Market behaves the way he wants and not what investors want .

In general, researchers have found that the illusion of control is more likely experienced  when following conditions are fulfilled:

  • One has early success at a task.
  • Many choices are available.
  • The task one is undertaking is familiar.
  • The amount of information available is high.
  • One has more control over the decision process.
  • One has a personal stake in the outcome of the choice.

How to overcome it ?

  1. The first step is to be aware of it. 
  2. Be open to the possibility of being wrong or getting wrong .  
  3. Honestly asking whether luck or just randomness played a significant role in initial success.
  4. Craft your investment plan / financial plan , define the framework and then stick to it.

Keep Learning and Happy Investing !!!

Nick Murray’s Advice

– Meghashyam Sinkar

Bull was dominating 2 yrs back on the market . Now Bear started dominating with the news of recession around the corner . Investors were grappling with the issue of whether to invest at high level 2 yrs back during bull markets and now with the issue of whether to invest in such depressed market with negative news looming around . The pendulum has swung , as Benjamin Graham ( Warren Buffett’s guru and an author of well known book – The intelligent Investor ) knew it always does , from irrational exuberance to unjustifiable pessimism.

I came across a very thought provoking set of core beliefs about Investing by Nick Murray ( which I am reproducing below. Nick Murray is a hugely successful US based financial advisor. He has been a financial advisory professional for more than fifty years and an author of a dozen books on financial services professionals .

His 10 core beliefs will help us to focus on what matters most for long term investing success.

1.        I believe that the fundamental investment risk is not losing one’s money, but outliving it.

2.        I believe, therefore, that the only safety lies in the accretion of purchasing power.

3.        I believe that the great long term risk of stocks is not owning them.

4.        I believe that everything you need to know about the movement of stock prices can be summed up in 8 words: The downs are temporary; the ups are permanent (for good managed businesses )

5.        I process the experience which most people describe as a “bear market” in two different words: big sale.

6.        I don’t believe in Individual Stocks, I believe in managed portfolios of stocks.

7.        I believe that dollar cost averaging will make the dumbest person in the world wealthy. Hey, look at me: it already has.

8.        I love volatility.

9.        I’m not afraid of being in the next 25% down tick. I am afraid of missing the next 100% uptick.

10.     I believe that, prior to retirement, people should own as close to 100% equity as they can emotionally stand. Then, after retirement, I believe they should own as close to 100% equities as they can emotionally stand.

If Investors embrace these 10 core belief and build convictions around them , then they can sail through this volatility happily to the path of successful wealth creation.

Happy Investing !!!


Cognitive Dissonance Bias

– By Meghashyam Sinkar

It is widely known and proven that tobacco use or smoking can harm the body & may cause multiple type of cancer , heart problem & unhealthy decreased life expectancy . Why do people still indulge or continue to engage in unhealthy behaviour .Everyone is aware of its side effect . The warning on the packet is quite vivid to understand . But then people convince themselves that ” its a just 2 cigarettes a day or A lot of things can kill you, can’t avoid them all. They try to rationalise which has conflicting thought with its basic truth or information .

The same thing is observed with morning walk . Everyone knows it how important or good it is to have morning walk . Initially there is conscious effort to continue with daily morning walk , but then justify why one can’t continue for number of reasons.

It is a response to conflict that allows our original beliefs to persevere, even in the face of contradictory evidence. It describes the discomfort felt when your beliefs are inconsistent with one another or with your actions. This is called Cognitive Dissonance bias in behavioural finance .

Cognitive dissonance is the unpleasant emotion that results from believing two contradictory things at the same time.

Within the realm of investing, cognitive dissonance can negatively affect investor behaviour as we rationalise a previously held belief, even in the face of contradictory evidence.

Let’s understand it with examples .

Example 1 :-

This bias is clearly observed in long term SIP investors . The ultimate benefit of the SIP is to accumulate the units irrespective of the short term market’s positive or negative movements . This is the information with which they start the SIP . However , as soon as market start declining in year or two , they start feeling nervous . They start questioning the basis of SIP i.e. rupee cost averaging concept .

Market Trend

Here , Situation 2 is much better than Situation 1 for regular long term investors . However , investors who have started the SIPs in last one or two years are worried now after seeing negative returns .Negatives events like economy slowdown , US China trade war etc are making the investors nervous . Some of them may stop the SIP in panic which is ideally injurious to their financial wealth .

In reality what should they be expecting after starting the SIPs or making regular investment ?

Market to rise in one direction which forces them to buy units at high prices at every instalment  OR  Market to fall down and remain low for longer period of time which helps them to buy units at lower prices ?

Strange isn’t it? They are aware what is right for them yet they are unhappy, feeling bad , nervous. It’s a perfect example of cognitive dissonance.

Example 2 :-

Let’s consider the current situation of market where there is lot of uncertainty mounting around . There is an Investor already invested in equities with long term horizon and knows very well that market will have strong volatility in between . He now believes that market is going to fall in coming 2 -3 months. He formed his opinion based on the many articles he has read on various websites and newspapers ( Nowadays what’s app forwards). Based on these theories he definitely believes that the market is going to go down.

He asked his financial advisor . Financial Advisor educates the client & suggests him to stick to his asset allocation & strategy .  However , client refused to listen to advisor and he cuts his portion in equity . A very next day market falls down by 5% . Client believed what he did was right.

After a month or so , the market rebounds again and looks good on fundamental terms . His advisor asks him to rebalance his portfolio again and suggests him to stick to his long term plan with decided asset allocation by investing in equities again . The client now regrets his decision and realizes that he has made a mistake but is not in a position to acknowledge his mistake.

The similar behaviour observed while investing in stocks .

The only way to overcome the negative effects of cognitive dissonance is to recognize  it and attempt to abandon such contradicting techniques. Investors who understand these differences become better investors and can take better decisions.

Happy Investing !!!