How We Think

Commitment Bias

It ain’t what you don’t know that gets you into trouble.  It’s what you know for sure that just ain’t so. – Mark Twain

Any honest post-mortem of the investment decisions we have made at Cook & Bynum over the past nearly ten years will reveal plenty of mistakes.  We have made mistakes because we lacked perfect information.  We have made mistakes because we improperly processed the information we did have.  And we have made mistakes because a variety of psychological misjudgments have undermined the rationality of our thinking.  Of course, it is not possible to avoid all mistakes, but we do work diligently to avoid, as Charlie Munger describes it, “our fair share of folly.”  We believe, as Mr. Munger has also previously stated, that the avoidance of a small percentage of mistakes will have a significant positive impact on our investment results over the next forty years.

We try especially hard to avoid the pernicious effects of commitment bias.  The psychologist Dr. Robert Cialdini defines commitment bias as, “our nearly obsessive desire to be (and to appear) consistent with what we have already done.” [1] Once a person makes a decision, the human tendency is to misprocess subsequent data in support of that original decision.  People twist new data to confirm a hypothesis rather than rejecting it and forming a new hypothesis incorporating these data.  This powerful tendency to remain consistent at all costs also results in people selectively gathering evidence and recalling only corroborating information from memory while concurrently ignoring contradictory information.  The compounding nature of successive mistakes caused by this bias can lead an investor into a powerful non-virtuous cycle.  When combined with other standard psychological misjudgments[2], this cycle can be potentially ruinous for an investor.

To avoid falling into these traps, we spend most of the time after we have purchased a security discussing and analyzing why we might have been wrong to have done so.  Given the presence and power of the aforementioned bias, the subsequent information that supports our decision to buy a company will be easily digested, but the critical information that reveals an error in our thinking will be much more difficult to process.  Therefore, our mindset must be one that involves constantly questioning all of our core assumptions about a business.  We should be thinking about hypothetical developments that would disprove our original assumptions or render them moot.  This type of thinking makes it more likely that we will recognize mistakes before they result in a permanent loss of capital.

We also attempt to avoid these psychological misjudgments by using a “buddy system.”  Anyone who has spent time with the two of us will tell you that we relish the opportunity to challenge each other’s ideas and assertions.  This activity is not simply good sport; we believe that this environment helps prevent either one of us from walking too far out on a ledge.  We are certainly capable of falling into groupthink, but many simple errors are avoided by our rigorous questioning of one another.  We do not know everything that the other knows, but we can generally ascertain when the other is outside of his circle of competence.

Interestingly, standard practice in the money management world is for managers to promote with great conviction the positive aspects of their holdings while ignoring or dismissing the negatives.  The manager is supposed to defend vigorously the decisions he has made.  This approach sounds good in the media or in investor meetings, and its practice is reinforced because it is effective in attracting new investor dollars.  But this behavior actually increases the probability of commitment bias because the commitment has been made both publicly and repeatedly.  For us, talking with potential investors about the appeal of Company A will likely decrease our chances of noticing or appropriately synthesizing contradictory information.  This type of proselytizing increases our chances of succumbing to commitment bias in our investment decisions.  Instead of resorting to this standard practice, when we are compelled to talk about our largest holdings, we try to open a window into our process of looking for the reasons why we might have been wrong to purchase the business in addition to why we own the business.  We believe that this is the correct strategy both for making intelligent investment decisions as well as for attracting the right kind of investors.

We suspect it is peculiar to devote a substantial part of our letter to a discussion of mistakes for the third time in a year, but we strongly believe that our commitment to challenging our own ideas is critical to your success.  We must remain appropriately detached from the businesses in which we invest in order to generate outsized returns over long periods of time.

[1] Cialdini, Robert B.  Influence: The Psychology of Persuasion.  New York: William Morrow and Company, 1993.

[2] For a discussion of these standard misjudgments, please see the talk/essay entitled “The Psychology of Human Misjudgment” found in Poor Charlie’s Almanack: The Wit and Wisdom of Charles T. Munger.