Stoic Investing

Human Misjudgment : Confirmation Bias

“I hated discussing ideas with investors, because I then became a defender of the idea and that influences your thought process.” ~ Michael Burry (The Big Short)


I’m sure this is one statement most of you will relate to. We often discuss stock ideas which, we understand, are contingent to future events but if we declare/discuss the ideas in public, irrespective of how the events unfold, it becomes extremely difficult (subconsciously) for us to change the stance we have taken in public.


Mohnish Pabrai of Pabrai Funds has often repeated during his annual investor meetings that he doesn’t discuss current stock investments as it clouds judgment.


I practice the same rule (but for a different reason – that of avoiding extreme embarrassment in future). :-)


This is a great mental bias and is the next powerful concept I want to discuss today. Along with the psychological tendencies we’ve discussed so far in this series on Mental Models, like reciprocation and liking/disliking, this one is also well discussed in Influence: The Psychology of Persuasion


As Cialdini explains, there is an obsessive desire to be consistent with what we have done or said in the past. He writes…


Once we have made a choice or taken a stand, we will encounter personal and interpersonal pressures to behave consistently with that commitment. Those pressures will cause us to respond in ways that justify our earlier decision.


He named this psychological tendency as ‘Commitment and Consistency’.


Munger in his speech uses the inverted version to represent the bias it causes and calls it ‘Inconsistency-avoidance bias’. He explains that the human brain conserves programming space by being reluctant to change.


Most of us who have made New Year resolutions to change an old habit need no convincing on the above statement as we have all experienced how difficult it is to change old habits.


There is a psychological force which resists the change and forces us to act consistently with past behavior that makes habits self enforcing.


Warren Buffett puts it very well – “Chains of habit are too light to be felt until they are too strong to be broken.”


At the subconscious level, commitment and consistency leads us to what we already know as confirmation bias, where we seek for new information in confirmation to older beliefs/decisions.


We have often seen it in various disciplines, especially science, that for years and years the work scientists do is incremental but the defining moments are not only often radical but are also the ones that are always rejected first. This is because they are inconsistent with the previous findings.


The effect of this bias is enhanced with the amount of effort one puts in reaching the older conclusions. More the effort, harder it is to change and higher is the probability to remain consistent with previous decisions.


Various cults, religions and clubs have used this tendency of humans to induce greater sense of devotion by increasing the effort required to be part of the group.


For investors and corporate managers, there are numerous occasions where they can observe this bias coming into action.


Business managers often find themselves in a situation where they keep on investing into a project till completion even if halfway down it’s obvious that it is inefficient use of capital. In Corporate Finance lecture we call it the “ sunk cost fallacy “.


In the wise businessman’s lingo, it’s called ‘throwing good money after bad’.


In corporate mergers and acquisitions, the same bias forces managements to keep on allocating more capital into a recent merger in an attempt to revive it.


Investors often face this bias in two ways (at least from my limited experience). First, it is very difficult and time consuming to change the stance on a particular stock in the light of new information. Most successful investors are able to change their views with great aplomb without getting affected by their primitive need to be consistent.


George Soros was famous for his ability to go from long to short on a particular stock if new information was disconfirming to his previous decision.


Second, it creates mental difficulties in capital allocation in a portfolio, especially if the new stock is going to replace an old stock.


Selling decisions often experience the commitment and consistency bias acting upon them. If one runs a concentrated portfolio which involves acquiring a substantial position in a company after a lot of effort, one can often find it difficult to change the opinion on the stock even if it’s warranted.


An amazing (and speculative) example is that of Warren Buffett, who didn’t sell Coca Cola and some other overpriced stocks when they were trading at extremely high multiples.


One reason could be his various public statements about the concept of ‘permanent investments’. I am not sure whether he would have taken a different decision if he wouldn’t have mentioned it in public, but my guess is that it would have been easier for him to sell. (For more details, please refer to Buffett’s 2004 letter to shareholders which has some great lessons)


Another frequent area where we observe this tendency in play is the constant effort from companies to meet their ‘guidance’.


Companies try various operational and accounting tricks to ‘meet the numbers’. On occasions, things go bad. Here is a very astute observation by Buffett in his 2000 letter to shareholders…


The problem arising from lofty predictions is not just that they spread unwarranted optimism. Even more troublesome is the fact that they corrode CEO behavior. Over the years, Charlie and I have observed many instances in which CEOs engaged in uneconomic operating maneuvers so that they could meet earnings targets they had announced. Worse still, after exhausting all that operating acrobatics would do, they sometimes played a wide variety of accounting games to “make the numbers.
These accounting shenanigans have a way of snowballing.
Once a company moves earnings from one period to another, operating shortfalls that occur thereafter require it to engage in further accounting maneuvers that must be even more “heroic.” These can turn fudging into fraud.


Reminds you of anything recent in the history of Indian equities?


Whenever I read this passage, I instantly recall a very catchy but apt phrase used by the CEO of a very prominent Indian organization – It was like riding a tiger, not knowing how to get off without being eaten.


Ramalinga Raju surely learnt his lesson on psychological biases in a very hard way. This is what he wrote in his 2009 letter to the board of directors on the eventful day the Satyam scam broke out…


The gap in the Balance Sheet has arisen purely on account of inflated profits over a period of last several years…
…what started as a marginal gap between actual operating profit and the one reflected in the books of accounts continued to grow over the years. It has attained unmanageable proportions as the size of company operations grew significantly…
…every attempt was made to eliminate the gap failed. As the promoters held a small percentage of equity, the concern was that poor performance would result in a take-over; thereby exposing the gap. It was like riding a tiger, not knowing how to get off without being eaten…


(Important note: Whenever an example like the above is used to demonstrate a particular psychological bias, it is important to understand that the bias is only part of the explanation for the event. Almost all prominent events like the one described above are results of lot of psychological biases coming together).


So, what are the antidotes? How can we avoid the traps and exploit this bias for our benefit?



  • Don’t be a defender of ideas: In an investing career, it is imperative to be able to change views and inculcate new information objectively. Don’t publicly commit to ideas if you feel the pressure or embarrassment to change your views later on.
    In the investment process, especially for the portfolio allocation problem discussed above, a very powerful antidote that has been practiced by many successful investors is that of mental liquidation of the portfolio to cash and then thinking what is the best use of the cash at the given time.
  • Do not make absolute statements in public: Scientists know this very well. Even before they reach the conclusions, they always hedge it by saying that the decision is on currently available information and can also change. This is also a true reflection of humility in science as compared to other pseudo sciences that tried to sell certainty.Salesmen have used this tendency of commitment and consistency by asking potential customers for smaller commitments. Once the customer agrees to the smaller commitments, the salesmen will then ask for larger commitments.
    You may have observed it especially in various charities selling where they request you to ‘just sign’ the petition. And when you have shown a commitment to the cause by signing the petition, they will often ask for a small donation for a cause ‘YOU’ feel so ‘committed’ to. Beware when making small commitments!
  • Practice being a destroyer of your ideas: This is very important, and also the toughest of all. Practice being a destroyer of your ideas and admit inconsistency when there is one. Not many people can do this but we can always learn from Keynes who when criticized for changing his position on monetary policy during the Great Depression, replied – “When my information changes, I alter my conclusions. What do you do, sir?”You can also use this to induce certain habits which you are struggling to otherwise.
    Declare your plans to your friends, family members or on any other public forum which compels you to stick to the task.
    I tried this for my blog and even though I have not written anything despite my public commitment I do feel immense pressure. (I am sure someday this pressure will eventually lead to action) :-)
    P.S. A few days back I was re-watching a great movie named “12 Angry Men”, which also shows a lot of psychological blocks within the various characters and one can especially observe the bias mentioned in this article. Do watch it!

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