Hard and illusory excellence bias: why even seasoned investors get frustrated

Most long-term investors are familiar with the phenomenon of sail bias or the “bandwagon effect”. It leads people to make investment decisions based on the belief that “everyone is doing it.”

This type of behavior is part of human nature, although in the context of the market, it is usually associated with novice retail investors who are not confident in making their own decisions and thus resort to panic buying or selling.

For example, the price of GameStop shares and the recent rise of the Dogcoin cryptocurrency, among others, seem to contradict fundamental analysis and are therefore generally blamed on Paul’s mentality. The same can be said about the dot-com bubble around the turn of the millennium.

When the price of extra purchased assets suddenly crashes, scholars often see it as a confirmation of conventional knowledge that the shift is always wrong.

And yet, in the case of Gamestop and Dogcoin, Robinhood traders are not the only ones to demand this asset. Veteran businessmen and institutional investors were part of the oppressed. Many of them have made money, and some have been burned.

Certainly the participants in this market – with their sophisticated algorithms and years of investment experience – have not lost to a sail mentality. So why did they join the flock?

The old adage says, “What you don’t know doesn’t hurt you, what you know for sure isn’t right.”

The irony is that most decisions are consistent with the decisions of the average investor. This is how the average works. If enough people believe that the assessment about their situation is higher (when it’s really just average), the sail forms.

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The illusion of superiority

Experienced investors tend to have a different kind of bias than Paul’s mentality – which can be equally disguised and perhaps more responsible for Gamestop and Dogcoin frenzy. This is called illusory superiority, and in short, it is simply an additional confidence that our decisions are both higher and more unique.

In general, anyone who makes an investment decision that is supported by a thoughtful thesis believes that the decision is right and ideal. Unfortunately, our perception of the norm is often bound up with misleading superiority bias, which leads to a misinterpretation of the truth and a wrong decision instead. Sometimes, this investment bias even makes us consciously or unconsciously ignore information that does not fit into our thesis, again leading to conclusions that are less than ideal.

The bias of illusory superiority does not only affect recognized investors in stocks and cryptocurrencies. Venture capital and private equity firms may suddenly find themselves in a profitable position due to overconfidence in a successful strategy or analysis method.

In fact, the bias of enchanted excellence is found in almost every aspect of life. In the academy it is closely related to what is known as the Dunning-Kruger effect, a cognitive bias that overestimates our abilities. This bias reflects our perceptions about everything from our driving ability to our relative popularity within a group. It is often innocent. But in terms of money management, it can be absolutely devastating.

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Stay on guard

So how do we check our investment decisions for signs of bias, whether it’s a sail mentality or illusory superiority? How do we make the right decision objectively when considering numerous variables?

The key is to adhere to first-principle thinking, based on internally developed results and every decision on the data. The defeat of Theranos proves wisdom in this advice. The so-called blood test agency, led by Elizabeth Holmes, brought in millions of dollars between 2013 and 2015 আগে even before the company’s flagship technology existed.

In the end, investors and prominent government leaders lost more than 600 600 million. The tension around Theranos was sustained by otherwise capable investors who followed and propagated a set of basic assumptions that proved to be wrong.

Here’s how to avoid this result: Be aware of our investment thesis when populating our deal funnel, keep our goal criteria in mind when reviewing every opportunity, and try to identify when the team is pursuing external influence leadership.

It is not always easy. This means actively rejecting ideas about what an ideal investor does and perhaps ignores popular investment strategies. Instead, our focus should be on internally specific outcomes.

Ignore rumors of funds that have returned 100 times the invested capital, and close criteria that do not match the life cycle of our team or fund. Set our objectives and key performance indicators to internally define what success looks like and set those goals to achieve.

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Our goal should be to control the forces that we can control while observing them. By being disciplined about freedom and objectivity, we can avoid emotional behaviors like panic shopping and sales and be more successful at identifying profitable opposite positions.

Taking this approach, we probably will Less Investment decisions, though Smart More. At the end of the day, we’ll be less likely to join the flock – and that’s a good thing.

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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.

Photo Credit: © Getty Images / Baona

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Dan Connor, CFA, FSA

Dan Conner, CFA, FSA, general partner of Ascend Venture Capital, is a micro-VC in St. Louis that provides financial and operational support to start-up founders looking at scale. Connor specializes in data-centric technology that enables future industry states. Prior to founding Ascend Venture Capital, Conner worked on the operations side of high-growth start-ups, a leading team in building scalable operational and financial infrastructure.

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