The cognitive bias everyone wants you to keep

Few mental biases will cut into your returns like commitment and consistency. 

There are dozens of cognitive biases that can affect your decision-making and lead you to buy or sell stocks at exactly the wrong time: confirmation bias, social referencing, anchoring and the bandwagon effect to name just a few. Each requires its own set of preparations, as we explain in The most common investor biases and their solutions.

This week, though, I was given a jarring reminder of another bias that creeps in - only this one is especially hard to shake because everyone around you is rooting for its success. In some ways, society is built on it.

Long story short, we switched our recommendation on Monash IVF (ASX: MVF) from Buy to Sell following the chief executive's resignation 10 months into his post. 

This isn't about Monash or the reasons for our decision, which you can find here. What caught my attention was the reaction of some of our members who were disappointed - horrified, even - that we might flip so quickly from Buy to Sell, overturning a Buy recommendation published only a few weeks ago.

Flip-flopping is certainly annoying and studies have shown that too much trading leads to below-average returns. The curious part, though, is that sudden recommendation changes actually run against a mental bias working hard to keep our recommendations steady: the Commitment and Consistency Principle

We all feel the need to keep promises and remain consistent with prior decisions. After we commit to something we tend to think up justifications for that commitment so that we feel we made the right choice. That goes for stocks just as much as sports teams and spouses.

Most of the time, this works great in society - people stick to their word, laws and verbal contracts are enforced, and everyone is just slightly more reliable than cold rationality might otherwise cause them to be. In investing, however, you need to foster that cold rationality. A stock does not know you own it.

Defender of the faith

After buying a stock you lose neutrality (especially if you make a public recommendation for others to buy it). This is no longer a random stock trading on the ASX, it's your stock; and there's a risk of becoming a defender of the investment case. New information that undermines that original case can quickly be brushed over or disregarded, which can lead you to hold on well beyond what's justified.

I can't say whether commitment and consistency bias was at play in our Monash recommendation, or whether it fueled some disgruntled comments. Maybe we held on too long as the evidence piled up that Monash's staff culture was in a shambles. Maybe we were right to wait for more evidence given its overall business quality and low valuation. Maybe we should have waited longer.

What I can say is that an ability to rapidly change your opinion when the facts change is an important quality in investing. It's not in spite of but because of our occasional flip-flopping that Intelligent Investor has consistently outperformed the market for 17 years (for our most recent audited recommendation report, click here).

The truth is, no amount of reading and understanding will completely immunise you from the commitment and consistency principle, nor the occasional nutty decision that follows. 

The best defence is constantly trying to kill your own ideas - and this idea-killing philosophy runs deep at Intelligent Investor. We're constantly having meetings and other discussions, trying to poke holes in any and every investment case or point out unanswered questions that require further research. 

This week Monash got the axe and it won't be the last stock on which we make an abrupt turnaround. Annoying as it may be, that's just what happens when you have tough investment hurdles and a constant stream of new information. A willingness to change your mind will serve you far better over time than trying to remain committed to your beliefs.

Disclaimer
Intelligent Investor provides general financial advice as an authorised representative under the AFSL held by InvestSMART Publishing Pty Limited (Licensee). InvestSMART Funds Management Limited (RE) is the responsible entity of various managed investment schemes and funds and is a related party of the Licensee. The RE may own, buy or sell the shares suggested in this article simultaneous with, or following the release of this article. Any such transaction could affect the price of the share.

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