CFI Blog

Lies, Damn Lies, and Anchors

“Above all, don’t lie to yourself. The man who lies to himself and listens to his own lie comes to a point that he cannot distinguish the truth within him, or around him, and so loses all respect for himself and for others.”
–Fyodor Dostoyevsky

73% of all statistics are made up on the spot.

“The best lies about me are the ones I told.”
–Patrick Rothfuss

When I was a kid, I played video games quite a bit. My parents gave me a Commodore 64 computer (even though I wanted an IBM because I wanted to learn how to program), and the C-64 had a ton of games. Occasionally, I’d find a book or a bulletin board system (forums in the pre-Internet days…when you would have to dial up using your 1200 baud modem to connect) that gave some cheat codes for games. I’d play the games, get frustrated, resort to the cheat codes, master the game, and think that I was the video game king of the world.

Until, of course, the next game came along and I’d get stuck somewhere, unable to get to the next level, beat the biggest bad guy, whatever.

Even though I had used cheat codes to make my character stronger or do whatever it was that would help me go through the game, I still convinced myself that it was my skill and not the extra help I’d received that made me a better player.

A recent experiment by Harvard’s Zoë Chance and Duke’s Dan Ariely showed that when we cheat, we’re very unlikely to attribute the results of cheating to the cheating itself, but, rather to our own brilliance (you can read a summary by the BBC’s Tom Stafford here).

As we’ll see in the article below, our propensity to convince ourselves that we’re better than we actually might be, along with a psychological hiccup called coherent arbitrariness can set us up for a long and painful ride as stock investors.

The Big, Fat, Whopping Lie We Tell to Ourselves


The experiment I mentioned above involved average college students who were asked to take a couple of quizzes as part of a study. Some of the students took a generic exam with questions and answers, and some of the students received an exam that had the answers written at the bottom of the exam. While it was impossible to tell which students who received the “doctored” (get it…it’s a college joke!) exam cheated, on average, the scores of the exam with the answers at the bottom were, unsurprisingly, higher than the ones without the answers at the bottom.

So far, we’ve learned nothing astounding. Given the opportunity to cheat, some people will, especially if they don’t think that they will be caught. However, it’s the subsequent behavior that is interesting.

The students were offered an opportunity to receive a cash prize of up to $20 if they could, given the performance on their first test, accurately predict how well they would do on the second test. There was a monetary incentive so that students would estimate their performance as accurately as they could. The second test had no answer key for any test taker.

Students who took the test with no answers overestimated their scores by about ½ of a question.

Students who took the test with the answer key at the bottom of the first test overestimated their scores by about 2 ¾ questions.

The mere act of cheating inflated the second group’s perception of their own ability by 2 ¼ questions.

As we saw in “Are You Allured by That Active Fund Manager’s Great Performance Last Year?”, we easily succumb to attribution bias, meaning that we use the wrong causes to explain outcomes. In this case, students thought it was their own brilliance that caused them to do well on a test rather than looking up the right answers on the answer key at the bottom of the test.

How Lies About Cheating on Exams Affects Your Portfolio

If we like to tell ourselves that good things happen to us because we’re smart (and gosh darn it, people like us!), how does that affect our choice of investments?

As the author of Investing Psychology (#aff), Tim Richards explains, we tend to value our investments based on relative valuation – how much is a stock valued compared to, say, its competitors in an industry – and some arbitrary data or factors – anchors which may or may not have any influence on the actual valuation of the stock. So, while there may be very little actual relevance between the mental system we use to determine valuation and the true valuation of what we’re investing in, we have a system, gosh darn it, and our system works! The name for this psychological bias is called coherent arbitrariness.

The problem with coherent arbitrariness is that what could become the factor influencing the creation of our mental model could have absolutely nothing to do with the actual value itself. We humans are very easily swayed by random numbers; as we saw in “Does Watching CNBC Give You Bad Habits,” we start to see patterns in the stock prices that are shown scrolling across the bottom of the screen on the CNBC trade ticker even when no pattern exists– a phenomenon called apophenia.

When you mix coherent arbitrariness with our willingness to make ourselves the hero of outcomes rather than, say, pure, random luck (for more on how luck affects your investing, see “Do You Have to be Lucky to Beat the Stock Market”), as we saw in the experiment involving students receiving the answer key and subsequently believing themselves to be better test-takers than they actually were, we’re potentially creating a heady cocktail of cockiness, lack of skill, and our nest egg.

I don’t know about you, but usually, when I mix ingredients I’m not familiar with into some sort of mixed drink, the results turn out nasty.

Let’s throw a final psychological bias into the mix: selection bias. Selection bias means that we tend to remember outcomes that are favorable to us rather than the ones that didn’t turn out well.

So, if you come up with an investing “system” (based on whatever it is that you’ve come up with) and invest in a few stock picks, here’s what your limbic system is going to do to you:

  1. Throw a few picks into the mixer. Wait a few days (or less) to see results.
  2. Pick the one or two winners out of the batch. Forget the rest.
  3. Tell your Thinking Self that you’re a genius! Your system works!
  4. Convince yourself to invest everything you have into that system. Fates be da…ed!

If you really, really, really have to invest and swing for the fences to soothe your psyche (and males are more susceptible to this than females), then use the 5% rule that I outline in “Play the Market Like a Hedge Fund Manager”. Don’t let Monkey Brain fool you into other follies.

By the way, that cocktail that I outlined above will lead to phrases like “I have this great system” or “investments that cannot lose,” which will sound like the drivel that is spouted by strip mall “investment advisors” or Internet banner ads – both of which have the same level of credibility in my book. If you hear phrases like that, run far, far away. The same goes for systems for betting on roulette or craps, although those systems might wind up losing you less money in the long run than a strip mall “investment advisor” will.

Author Profile

John Davis
John Davis is a nationally recognized expert on credit reporting, credit scoring, and identity theft. He has written four books about his expertise in the field and has been featured extensively in numerous media outlets such as The Wall Street Journal, The Washington Post, CNN, CBS News, CNBC, Fox Business, and many more. With over 20 years of experience helping consumers understand their credit and identity protection rights, John is passionate about empowering people to take control of their finances. He works with financial institutions to develop consumer-friendly policies that promote financial literacy and responsible borrowing habits.

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