Why You Never Learn From Your Investment Mistakes

Study successful investors, and you'll notice a common denominator: They are masters of psychology. They can't control the market, but they have complete control over the gray matter between their ears.

And lucky them. Most of us, on the other hand, are mental catastrophes. As investor Barry Ritholtz once put it:

You're a monkey. It all comes down to that. You are a slightly clever, pants-wearing primate. If you forget that you're nothing more than a monkey who has been fashioned by eons on the plains, being chased by tigers, you shouldn't invest. You have to be aware of how your own psychology affects what you do.

Take one of the most powerful theories in behavior psychology: cognitive dissonance. It's the term psychologists use for the uncomfortable feeling you get when having two conflicting thoughts at the same time. "Smoking is bad for me. I'm going to go smoke." That's cognitive dissonance.

We hate cognitive dissonance, and jump through hoops to reduce it. The easiest way to reduce it is to engage in mental gymnastics that justifies behavior we know is wrong. "I had a stressful day and I deserve a cigarette." Now you can smoke guilt-free. Problem solved.

Humans are one of the only creatures that engage in this self-deluding behavior. In their excellent book Mistakes Were Made (But Not By Me), Carol Tavris and Elliot Aronson write:

A dog may appear contrite for having been caught peeing on the carpet, but she will not try to think up justifications for her misbehavior. Humans think; and because we think, dissonance theory demonstrated that our behavior transcends the effects of rewards and punishment and often contradicts them.

Yes, when it comes to learning from bad behavior, you are at a disadvantage to an incontinent puppy.

Cognitive dissonance is especially toxic in the emotional cesspool that is managing money. Raise your hand if this is you:

  • You criticize Wall Street for being a casino while checking your portfolio twice a day.
  • You sold your stocks in 2009 because the Fed was printing money. When stocks doubled in value soon after, you blamed it on the Fed printing money.
  • You put $1,000 on a hyped penny stock your brother convinced you is the next Facebook. After losing everything, you tell yourself you were just investing for the entertainment.
  • You call the government irresponsible for running a deficit while simultaneously saddling yourself with an unaffordable mortgage.
  • You buy a stock only because you think it's cheap. When you realize you were wrong, you decide to hold it because you like the company's customer service.

Almost all of us do something similar with our money. We have to believe our decisions make sense. So when faced with a situation that doesn't make sense, we fool ourselves into believing something else.

Worse, another bias -- confirmation bias -- causes us to bond with people whose self-delusions look like our own. Those who missed the rally of the last four years are more likely to listen to analysts who forecast another crash. Investors who feel burned by the Fed visit websites that share the same view. Bears listen to fellow bears; bulls listen to fellow bulls.

Before long, you've got a trifecta of failure: You make a bad decision, rationalize it by fighting cognitive dissonance, and reinforce it with confirmation bias. No wonder the average investor does so poorly.

Great investors are different. They are practically allergic to these biases.

Value investor Mohnish Pabrai has an outstanding long-term track record, but he spends an inordinate amount of time analyzing his mistakes.

In an interview last year, Pabrai told me about his response to 2008, when he (and nearly everyone else) lost a lot of money. Rather than rationalizing his poor performance by blaming Wall Street, he set out to learn from what were, after all, his investment decisions. "I clearly studied my own mistakes, and I went back systematically and documented why we lost money on these different investments," he said. Studying his mistakes eventually led to a checklist Pabrai now consults before making new investments. "The checklist significantly brought down the error rate," he said.

Most investors don't think like this. Which is why Pabrai outperforms most investors.

Billionaire Ray Dalio is similar. His hedge fund, Bridgewater Associates, has a policy that every employee must always speak their mind, even if it means telling a superior they're wrong.

"Successful people ask for the criticism of others and consider its merit," Dalio writes in his employee handbook. "Remember that your goal is to find the best answer, not to give the best one you have."

Most investors don't do this. They assume their opinion (or the opinion of those who agree with them) must be right, and will delude themselves into justifying a belief when shown opposing facts. Dalio doesn't put up with this behavior -- which is part of why he's a billionaire, and you and I are not.

"The brain is designed with blind spots," Tavris and Aronson write, "and one of its cleverest tricks is to confer on us the comforting delusion that we, personally, do not have any." Alas, you do. And they're preventing you from becoming a better investor. Fight them as hard as you can.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics. 

Read/Post Comments (19) | Recommend This Article (123)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 30, 2013, at 10:24 AM, Raphael1990 wrote:

    Is there an article of you that links to the full video of the Pabrai interview?

  • Report this Comment On May 30, 2013, at 10:27 AM, TMFMorgan wrote:


    Here's the video on Pabrai on learning from mistakes and implementing his checklist:


  • Report this Comment On May 30, 2013, at 1:25 PM, SkepikI wrote:

    Morgan- A pretty good article on an ESSENTIAL topic. Understanding your own psychology, and particularly where your blind spots as well as what I like to think of as "panic points" is key to avoiding investing mistakes. It is why I stay away from certain types of investments and certain types of individual stocks, even when they ultimately prove to be good investments. Paradoxical, I know, but even a good investment becomes a bad one when you panic at the wrong moment. Just ask all of the formerly happy APPL shareholders who bought at 700 or 500 and then sold out at 400 because they couldn't stand it anymore. No I dont know any personally, but all I have to do is look at the market graph to know there were some. And, all I have to do is understand my own mistaken investing behavior from the past to know that would have been me too, had I been overconfident enough to buy at 700.00/sh

  • Report this Comment On May 30, 2013, at 8:18 PM, lngtrmcptlgns wrote:

    Morgan, another great article.

    Speaking of the poor performance of the average investor...

    If you haven't already, I would LOVE to see you write an article about the issue of just how many retail investors HAVE A CLUE what their actual portfolio performance is (in terms of a CAGR, compound annual growth rate).

    I have my investing accounts with Fidelity (a Roth, 401k, and regular taxable account) and they do NOT provide me with a CAGR for any of the accounts (much less the 3 combined, which is what I really want to know).

    I even called and asked them, and the rep flat-out said they don't provide it, but "had been asked about it and hoped to provide it in the future".

    I called the famously investor-friendly Vanguard and asked if they provided their account-holders with a total portfolio annual return, and the rep said they do NOT.

    I understand that an investor can calculate his or her own portfolio CAGR with a spreadsheet, and am in the process of figuring that out myself.

    How can the average retail investor make smart decisions about his or her stock-picking strategy, if they don't know how well or poorly they are doing?

    As you know, under or out-performing a "basket of passive index funds" strategy by just a couple of percentage points a year can make a fairly shocking difference in the size of a nest egg over an investing lifetime for someone who is trying to pick their own stocks.

    PLEASE illuminate us with a smart article about this topic, and hopefully give us some guidance on figuring out our performance ourselves.

  • Report this Comment On May 31, 2013, at 12:52 AM, awallejr wrote:

    Personally I think this a silly article. People should be learning from their mistakes, and I suspect most intelligent people do.

  • Report this Comment On May 31, 2013, at 3:23 AM, n4g4 wrote:

    Great article. I've read a few books on cognitive dissonance recently and was fascinated to observe how often it comes into play during daily life. Facebook is probably the biggest arena for cognitive dissonance since it provides an ideal platform for confirmation bias.

    The knee jerk reaction is to reject CG. People aren't willing to come to terms with how little in control of themselves they really are. We are conditioned by so many factors in our environment we overlook the self conditioning thoughts that plague us over and over throughout the day. Silly primates.

  • Report this Comment On May 31, 2013, at 5:19 AM, Fabin81 wrote:

    Great article but unfortunately too general to be applied by most people.

  • Report this Comment On May 31, 2013, at 6:03 AM, sikiliza wrote:

    Guilty as charged. However, I try my best to analyze both my successes and failures and I am slowly learning to check my emotions at the door and wipe off my excuses before I invest. It takes time but I have the patience.

  • Report this Comment On May 31, 2013, at 1:16 PM, TMFDarwood11 wrote:

    It's useful to understand that perhaps the only thing we can control is what goes on in our head. That's what I got from this article.

    I doubt if Pabrai listens to market pundits.

    For the man in the street such as myself, the issue is getting advice or getting an education. For Parbai the exercise is to get an education so that he can make better decisions. I suggest that is the better path to wealth.

  • Report this Comment On May 31, 2013, at 1:52 PM, WallStreetRanter wrote:

    Interesting antidote about Mohnish Pabrai making his checklist....but hopefully he realizes that his "checklist" hasn't been put to any test since he only implemented it after the last crash......another common error of investors....not realizing when their "good fortune" is nothing more than the result of a bull market....

  • Report this Comment On May 31, 2013, at 4:47 PM, SkepikI wrote:

    awallejr- if you watch humanity critically for a while, particularly "investors" you realize that while most people SAY they learn from their mistakes, they do not. AND if you watch yourself critically for a while you realize that you don't either, unless you force yourself to look at your messes, and act to avoid more, even when all about you are cheering you on to new lunacy. Even then, sometimes you slip up. I nearly did with FB or "Faceplant" as I like to call them. Not that FB cant come out as a good investment. I was so very tempted to ignore my basic investing strategy and go for "just one high risk growth op" Having beat that temptation down, I watched with great interest what transpired and projected what I would have done, which was to sell out at a loss after the first disappointing month. (yes its a character flaw I know, but one I admit and understand)

    It is why I refuse to invest in DDD at stratospheric P/E even though its owners are doing extremely well. Except for the ones that bought at 50 early and sold out at 38 unable to bear the angst (that would have been me had I bought too)

  • Report this Comment On May 31, 2013, at 6:19 PM, Chuck2010 wrote:

    Regarding Fidelity and reporting investment returns:

    They do provide it for some accounts. I have had an account since 1993. They seem to have instituted performance tracking back to 2003 for my IRA's via the online access they provide. It gives you the option of annualized and cumulative returns for YTD, and rolling 1 year, 3 year, 5 year, 10 year, and from inception of account (only seems to go back to 2003 though). For an account I help my mom with at Fidelity, her account does not show any performance tab in the online access. I am not sure why but I suspect they don't do the math if the account is less than 5 years old.

  • Report this Comment On May 31, 2013, at 6:46 PM, TempoAllegro wrote:

    Does anyone recommend a good book or two on how to master market psychology? Thanks for the thought-provoking article - got my mouth watering for more!

  • Report this Comment On May 31, 2013, at 10:43 PM, SFJ42 wrote:

    I second the book request. Can we get a Morgan Housel suggested market psychology reading list?

  • Report this Comment On June 01, 2013, at 8:03 AM, TMFMorgan wrote:

    temp, sfj42,

    Here are a few good psychology books:

    Your Money and Your Brain (Jason Zweig)

    More Than You Know (Mauboussin)

    Thinking, Fast and Slow (the bible of cognitive psychology, but not specific to money. By Kahneman).

    The Science of Fear (Gardner)


  • Report this Comment On June 04, 2013, at 7:20 AM, gcp3rd wrote:

    I'll quick add: great article on a key part of investing money and I've added some of the books to my Amazon wish list.

    Second, I completely agree an article on determining CAGR of personal investment accounts is in order. In another article on MF today the author mentioned doing this for a portfolio he was working on. I recently called my IRA custodian to get all my past years contributions to make sure I had that info. Now I need to learn about the spreadsheet formula that will calculate the real return.

  • Report this Comment On June 07, 2013, at 3:33 PM, drborst wrote:


    Nice article, except for one thing. I suspect Ray Dalio is a billionaire because he runs a hedge fund and charges large fees for his sage advice. While you are not because you are a writer who charges a lot less.

    (I'm also not a billionaire, given that I read your articles weekly, its a cognitive dissonance I'm still trying to justify)


  • Report this Comment On June 07, 2013, at 4:53 PM, firethequeen wrote:

    Thank you for the article, Morgan. I underscore your book suggestions, having read Kahneman and Gardner. Seems like unlearning certain habits or changing our pattern behavior is one of our biggest challenges in investment decisions. Insightful and meaningful content--Kudos to you, Morgan!

  • Report this Comment On June 08, 2013, at 7:25 PM, Zombie111 wrote:

    Very useful article that I am going to use in clinical practice (I am a clinical psychologist).

    And agree with the reply to awallejr: people usually repeat their mistakes unless something major happens that forces change e.g. going broke or losing their marriage. And even then, their are many who do not see that the major common denominator in their life and problems is themselves.

    Blaming others or fate is so much more fun.

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