Why We Misunderstand Each Other and How it Impacts Our Investing
Happy Monday, and welcome to all the new subscribers. Mastering Your Money is where I share what I've been learning in investing and personal finance. Today I am excited to share a few thoughts on mindset.
"The most important quality for an investor is temperament, not intellect." - Warren Buffett
We will explore a 2017 episode of the Rule Breaker Investing Podcast. In this episode, David Gardner visits with Nick Epley, author of Mindwise: Why We Misunderstand What Others Think, Believe, Feel, and Want. Their conversation is filled with valuable takeaways about life and investing.
Mindwise discusses the ways our brain causes us to make assumptions and misunderstand others. We will take a quick look at how this happens and then see if we can tie it back to investing by the time we're through.
Here we go!
4 areas of misunderstanding:
Overconfidence
The Power of Story
Extrinsic Vs. Intrinsic
Intentions Vs. Actions
1. Overconfidence
We think we can predict what others are thinking, but we are far worse at it than we realize.
"Another person's mind is the most complicated thing you're ever going to reason about … yet we reason about other minds almost as easily as we breathe." - Nick Epley
"Whenever you get a situation like that, where a judgment is really easy, but the reality of it is really hard, you're likely to get overconfident." - Nick Epley
One reason why? We are egocentric - We assume others think more like us than they do.
This surfaces even in our most important relationships.
In a study with couples married an average of 10 years, each person answered 20 questions about themselves. Then their spouses were asked to predict how they responded. They accurately predicted their spouse's answer an average of 4.9 times. When asked how many they thought they got right, they answered 12.6. They were 2 1/2 times more confident than they should have been.
Takeaway: We are missing opportunities to connect with those closest to us. We need to spend more time asking and listening.
2. The Power of story
The stories we tell and the processes we go through to explain other people's behavior turn out to be the same processes that we go through to explain our own behavior.
When we observe an action, we tell a story about that person or ourselves that is consistent with that action.
"We quite quickly and naturally go from behavior/observed actions to something that's going on in someone's mind ... The simplistic inferences we make about people's minds are really the most common source of error." -Nick Epley
Example: Someone votes for a particular candidate, so we use one piece of information to tell a story about them that may or may not be accurate.
Takeaway: This creates an incomplete picture of others based on assumptions. We shouldn't tell stories about others or ourselves based on one piece of a complicated puzzle.
3. Extrinsic Vs. Intrinsic Motivation
Research shows we are more motivated by intrinsic sources than extrinsic.
Because intrinsic motivation can't be seen, this creates an issue. We know when we are motivated by a sense of pride or excitement or when our work comes from a place of deep meaning and value, but we can't see this in others.
This causes us to judge others, assuming they are only motivated by extrinsic (money, promotions, etc.) incentives.
Takeaway: We need to give others the benefit of the doubt and not make assumptions about their motivations. If we want to know what motivates them, we need to ask.
4. Intentions Vs. Actions
"People tend to evaluate themselves based on their intentions but evaluate others in terms of their actions." -Nick Epley
"You'll give yourself credit for conscientious plans that you made, but you'll only give other people credit for conscientious actions that you observed."
Example: "People will give themselves credit for planning to throw a Birthday party, but they will only give other people credit if they actually throw the birthday party."
Takeaway: This creates an unfair playing field that causes us to assume we are better than others. If you are unsure of someone's intentions, ask them and have a conversation.
Now what?
By now, you have probably noticed a pattern. The issue with each misunderstanding is our brain's habit of making assumptions with incomplete information. If we want to understand others, we need to have intentional conversations. These conversations should come from a desire to understand and not from a place of judgment.
But what does this have to do with investing?
Investor Overconfidence
One of my main investing takeaways from listening to this conversation was the importance of diversification. Understanding how our brain can take incomplete information and tell a compelling story is a good reason to spread out your bets.
Even in an age of 24/7 news cycles, we cannot know how the story will play out. Placing limits on the amount of capital you plan to invest in one holding limits the amount you can lose based on an overconfident assumption.
Evaluating Leadership
This conversation also made me think about leadership teams. We often want to know how much stock the executives own. We ask, "Do they have skin in the game?" It's important to know and a valuable piece of the puzzle, but we rarely consider the intrinsic motivators.
Perhaps understanding the intrinsic motivations of a CEO can paint a better picture and give us more confidence. But then again, how can we trust that confidence if it's built through an incomplete story we are telling based on the incomplete story the CEO is telling?
I may have taken that a little too far, but you get the point.
I think there are several valuable takeaways from this conversation. I would love for you to listen to the podcast and share your takeaways. Let's connect on Twitter
If you're interested in Mindwise or other books highlighted on the RBI Podcast, check out the Rule Breaker Investing Reading List.
Thanks for reading!