The mental models of GroupThink are strategies that are useful in financial and investing decisions whenever we work in teams. In Groupthink Part 1: #3 we take a deep dive into the benefits of thinking in groups and how our mental models change through group interactions. Other people help us to flesh out our mental models in a variety of situations. We decided to cover it in two podcasts: Groupthink Part 1: #3 | Groupthink Part 2: #4 coming next.
Experimental Psychologist Irving Janis described a set of common biases that impact people when they think in groups: Groupthink
Seeking multiple opinions can give you a wider perspective, but other people’s opinions can have an oversized effect on your thinking. Benjamin Graham spoke and wrote about the quality of your analysis making a big difference, but also that listening to groups can aid you to be a better investor. Add link
“You are not right or wrong if you are against the group, its’ more the quality of your analysis” Benjamin Graham
Psychologists call this process of understanding motivations of others “theory of mind”. Trying to understand others’ mental models is important because others can be right, wrong, or even misleading. A good strategy is to consider other people’s perspectives and to reflect on them to consider what is really useful information. Groups lead us to adopt a herd mentality – looking out for the lion the on the Serengeti. Emotion and being led by the group dynamicsEmotionally charged information is very difficult to ignore. Following the group can be effective in investing when you buy what everyone likes, but this can become risky if you don’t understand the reasons behind why the purchases were made. The head mentality in investing can be very dangerous – hear Georges burning theater analogy and better understand this concern. It can result in a downturn in your investment and leaving you without a clear sense of what to do next.
A reason not to participate in the mania in the group setting!
Being part of an investment club or team can be helpful as long as you follow a clear set of procedures: Listen to Groupthink Part 2: #4 for more information on this topic.
What is the FANG effect and the amazing companies that are a part of it?
Dan and George also discuss several concrete benefits and risks that can occur when you go with the crowd and when you go against it.
George answers the following questions and provides winning tips:
What are ways to gage the sentiment of the investing group?
Can you canvas a wide swath of investors to get a read on what they are doing in the market?
George explains what a “castle in the clouds” is and what it represents for investors
George discusses the herd effect, through an insightful analogy – should your push the school bus up the hill or jump on board and let others push?
Possible solutions for common cognitive biasesHaving checks and balances is important to prevent illusions of control, illusions of invulnerability, and overconfidence bias. In-group bias is a situation where we want to follow along with what others are doing for fear of missing out. We revisit this topic in Groupthink Part 2: #4 and focus on the specific risks and benefits of working on investment teams. How does expertise influence groupthink?
Expertise influences our thinking in groups with additional positive and negative implications. Sometimes you can know too little or too much.
George discusses the housing market and the associated changes and or risks.
With too much expertise you may become carried away with taking your mental model too seriously as being ground truth.
Example: playing poker expert vs. novice
A novice can bring a fresh perspective to the market.
Example: sell side vs buy side analysts may take a while to see “green shoots” or a clear V effect if they have suffered through several negative data points, before they can see the positive data points. While a novice will be more open to the “green shoots”.
Are there benefits to Groupthink in investing?
Groups can serve as a “mental speed bump” bringing up issues that you may not have considered, which can help your analysis: Listen to Groupthink Part 2: #4 for more information on this topic. We must walk a fine line between being confident in our own unique opinion and following the advice of others and are at risk of developing an in-group bias.
A lone wolf in investing sounds great, but risks not having a different perspective to purvey their assessment.
Also, risking the allusion of control as a lone wolf investorGeorge presents the analogy of everybody on the school bus and know body is left to push it up the hill – what does this analogy mean for investing, can’t be good?!?!
The take away message, have a check and balance system to give you structure and protect from Groupthink and associated cognitive biases.
Listen to 4: Groupthink Part 2 for further exploration of the in group dynamics when working with a team of investors.