People are more likely to believe things they want to believe.
At the same time people think that they are objective. A way to
get out of this predicament is to look at the evidence and try to
come up with a justification which would convince them that they
should either reject the evidence or find a subset of evidence
which is comforting.
People don't think that they hold a particular belief just
because they want to hold it. They are generally unaware that the
evidence can also be looked at in a different way or there are
other facts to consider. The process of getting from evidence to
belief itself is biased by our goals.
For example - when the initial evidence supports our theory, we
are happy to stop there and ask no further questions. But when
the evidence is against it, we go deeper. We attempt to either
find evidence to discredit the first hostile evidence or
discredit the source of the evidence. By asking more and more
questions in such a biased manner, we dramatically increase our
chances to discover evidence which is comforting to us.
Reality is complex and any situation you can think of is fraught
with complexity and open to alternative interpretations. Look at
the situation of Herbalife (
). Is it a pyramid scheme ? Will the government step in and
destroy its business model ?
seems to think so. But Dan Loeb and
do not share his beliefs and disagree with him. So much so that
they are willing to take the opposite trade. Ackman has done his
due diligence and the other two managers know about his
conclusions but they do not agree with it. Assuming that all
three have exactly the same evidence - the difference in
conclusion supports the theory that there are alternative ways to
interpret the data.
A Greek philosopher took on a student to teach him rhetoric
so that the student could practice law. In return the student
would pay when he won his first case. After his studies the
student decided against practicing law. The philosopher sued the
student and claimed that now the student has to pay him his dues
in either case. If the student wins then he must pay because of
the contract and if the student loses then he must pay by the
order of the court. The student countered that if he lost then he
would not pay because of the contract but if he won then he would
not pay because of the order of the court.
A different way is that people use different criteria to evaluate
evidence and come up with a conclusion. For example, people have
a very inflated opinion of themselves. They, on an average, think
of themselves as better looking, more moderate, less racist, more
open minded, better drivers, and better lovers.
Not surprisingly, careful people give more weight to being
careful, savers give more weight to savings, beautiful people
give more weight to beauty while humble people give more weight
to humbleness. Everyone has their own idiosyncratic idea about
what criteria needs to reach a particular conclusion.
In an experiment a group of university students were asked to
rate the importance of academic skills (e.g., math, public
speaking) and personal skills (e.g., creativity, meticulousness)
in terms of how important they are for success in college. The
students were also asked to rate their own ability on those
characteristic. Not surprisingly, the characteristics where the
students excelled were also the ones they rated highly for a
successful college life.
In a paper by Dunning, Meyerowitz and Holzberg, it was found that
the predisposition to rate oneself better than the average was
reduced when people were required to use specific definitions for
each trait. This is probably the most important part for
investors. When you have a clearly defined set of definitions and
rules - you will have smaller risk of getting biased by your
inherent need to "fit data to reach a specific conclusions."
Juggling criterias is one of the ways in which we get sidetracked
into investing into a bad stock. Even after having a checklist of
criteria (say circle of competence, financial strength,
management, moat, and margin of safety) we make mistakes in
reaching to a rational conclusions. Do we prefer strength over
management ? Moat over margin of safety ? Or everything is
Consider the case of a woman who has three equal weighted
criteria to select a car - look, price and power. Consider the
ratings of the cars as shown in the table below (1 represents
best and 3 represents the worst).
We discover something very curious. Let us compare Car A and Car
B. Car B is better in Price and Power compared to Car A. It is a
no-brainer that she should prefer Car B compared to Car A.
Comparing Car B with Car C she observes that Car C is better in
both Look as well as Power. So, she should prefer Car C in
comparison to Car B.
But comparing Car C with Car A shows that Car A is better both in
Look as well as price. So, she should prefer Car A over Car C.
This paradox is known as the Condorcet paradox.
Summary: B is better than A, C is better than B but A is
better than C !
Conclusion: having equally weighted criteria can lead to
The solution is not very satisfying. The only way to avoid the
paradox while maintaining the spirit of the experiment is to have
a deciding criteria which supersedes all others (Arrow's
impossibility theorem). For example - she might say that she is
going to take the cheapest car.
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