How your brain crushes your portfolio

“Billions wiped off share markets”, is a headline that has become all too familiar, as stocks around the world adjust to high inflation, rising interest rates, and the war in Ukraine.

With dramatic headlines such as these, it can lead many to be fearful and panic. It also plays into the hands of a mental shortcut called the Availability Bias. This is the tendency to believe that memories that are easily recalled (particularly the dramatic and most recent) are more representative than what they really are.

We can see the Availability Bias in everyday life. For instance, shark attacks for many people are a frightening concern. Surprisingly though, on average, there are only 10 shark attack deaths annually around the world.

In the US, there is an average of one shark attack death every two years, whilst annually, there are 4000 drowning deaths, 750 bicycle fatalities and 41 people killed by lightning strikes. The contrast is extraordinary, yet shark attacks grab our attention, because they are dramatic.

We also overestimate our chances of dying in an airplane crash. Many have a fear of flying despite the fact crashes are extremely rare. In fact, there is more chance of a person being killed in the car on the way to the airport, than dying in a plane crash.

If we should fear something it’s heart disease, which has been the leading cause of death globally for over 20 years. But many don’t think of it because it isn’t so dramatic (until of course, it is).

In investing, the Availability Bias can cause us to focus on the most recent and dramatic headlines, whilst ignoring the bigger picture – which is investing for the long term. It can also lead us to miss out on the opportunities that the cheap prices present.

There is a solution to the Availability Bias, and that is a prepared mind, which can protect us from short-term thinking and help us take advantage of opportunities.

The writer, William Arthur Ward said, ‘Opportunities are like sunrises. If you wait too long, you miss them’. When opportunities come our way, we must be ready to seize them, and that requires us to be prepared.

Preparation is a key investment principle of Berkshire Hathaway’s vice-chairman Charlie Munger. He said, ‘Our game is to recognise a big idea when it comes along, and they don’t come along very often. Opportunity comes to the prepared mind’.

According to Charlie Munger, there are five ways to have a prepared mind. They are:

1. Be a lifelong self-learner. Read voraciously, cultivate curiosity, and strive to become wiser each day.
2. Have the will to prepare, which is more important than the will to win.
3. Know the mental models (the big ideas from the major disciplines) to fluency.
4. Have an exhaustive knowledge of the investments that you want to make.
5. Have cash on hand.

We should always be ready to seize opportunities when they arise. Munger said, ‘Really good investment opportunities are not going to come along too often and are not going to last too long when they come. You’ve got to prepare yourself to act during this brief period. And that takes a prepared mind. It’s just that simple’.

One of Warren Buffett’s guiding principles is, ‘Be fearful when others are greedy, and be greedy when others are fearful’. So how do we navigate this principle when markets are crashing around us?

Howard Marks said, ‘It’s my view that waiting for the bottom is folly. What then should be the investor’s criteria? The answer is simple: if something is cheap – based on the relationship between price and intrinsic value – you should buy, and if it cheapens further, you should buy more’.

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