5 Kinds of Stupidity That Investors Really Need to Avoid

If you've ever encountered a brilliant author who refused to deal with balancing their checkbook or a scientific genius who couldn't manage interpersonal relationships, then you probably already understand that there are many different types of intelligence. The famous developmental psychologist Howard Gardener described nine, for example, and other clever researchers have come up with their own classification systems.

A couple of months ago, Morgan Housel of venture capital firm The Collaborative Fund -- and a former Motley Fool writer -- stopped in to the Motley Fool Answers studio to talk with host Alison Southwick about five kinds of smart that wise investors would do well to nurture in themselves. For this show, he's back to take a run at the flip side of that coin: five kinds of stupidity that are all too easy to fall victim to -- especially in investing -- and that we should work to recognize and avoid.

He'll talk with Southwick about:

• "Intelligence creep" -- the trap of thinking that being smart within your area of expertise translates to competence outside of it
• Overestimating the repeatability of your lucky wins
• Discounting the ideas of people who lack your credentials and background
• Not recognizing the key difference between tests in the classroom and "tests" in the real world
• Falling prey to "closed-system thinking"

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on July 9, 2019.

Alison Southwick: As Jeff Bezos once said, "The older I get, the more I realize how many kinds of smart there are." There are a lot of kinds of smart. There are a lot of kinds of stupid, too. Joining us today in studio is Morgan Housel with The Collaborative Fund. A few weeks back, you were here to talk about different kinds of smart, and now we're going to cover different ways of being stupid that you, too, can avoid.

Morgan Housel: Maybe!

Southwick: I don't know!

Housel: Maybe not! Maybe some people can't avoid it.

Southwick: Well, let's try! Acknowledging them is the first step to avoiding them. The first one is intelligence creep -- not knowing the boundaries of what you're good at and assuming talent in one area signals skill in all others.

Housel: There's actually studies on this that single out doctors, studies of doctors, that doctors tend to make very poor investors.

Southwick: I was totally going to say doctors!

Housel: I think it's hard to actually pinpoint the cause of this, but what makes a lot of sense is that doctors who are very smart in one field, they're very talented, by becoming doctors, they have great standardized test scores, they're very intelligent, and they assume that that intelligence should transfer over to their investing abilities. And so they tend to take much more risks with their investing, they have much more confidence or overconfidence with their investing abilities, that leads to poor returns. I think it's one of these things that's so hard for people to wrap their heads around, because people who fall for this bias are very smart and very successful. It's hard to tell them, "That doesn't mean that you're also good at something else."

Southwick: Hurts your ego, man!

Housel: A doctor would never assume that because they're a smart doctor they're also a good plumber or electrician. But that's obvious, that the skill shouldn't transfer. But I think, for whatever reason, investing, there's this idea, "I'm a smart person, so I understand the economy, I understand how markets work," even though it's such a completely different skill. I think a lot of it is, a lot of skills that people are very intelligent about are hard sciences -- medicine or physics or biology or something -- where there's a right answer for questions. Investing is just so nuanced, and it's governed by behavior that's messy, and there's an exception to every rule. I think that trips a lot of people up.

I think another category beyond doctors are engineers. Engineers have a precise answer for everything, down to the tenth decimal point. In investing, that's not how it works. Investing is about the odds of success and room for error and being OK with being wrong 60% of the time, but still doing OK. It's a very different dynamic than what exists in engineering, where there's a precise answer for everything.

Southwick: Right, right. I also think of doctors as being very comfortable with large amounts of debt at a young age because of student loans.

Housel: Because they have to.

Southwick: Because they have to. And then, they also have a lot of money to make mistakes with. They're higher earners. So, rather than the trope that doctors are really bad aerospace engineers, we get investing.

Housel: Right. Thankfully not building airplanes.

Southwick: Right?

Housel: If they thought they were good aerospace engineers.

Southwick: All right, No. 2, underestimating the complexity of how past successes were gained in a way that makes you overestimate their repeatability. Is this about luck?

Housel: Yeah. I could have just written "luck," but I rambled on. I think this is especially true in investing, where during one bull market, you do really well, and therefore, you assume, "Here's what I did during this bull market, and therefore, I'm going to do it again. I'm just going to take what I did last time and do it again," without realizing that markets evolve over time, and what worked during one period of time might not work during the next period of time. This is especially true if you look at something simple like growth versus value investing. You go through these 10- or even 20-year periods where growth investing does really well -- which is the past 15 years. But, before that, there was a period where growth did terrible and value did really well. So unless you're willing to have a flexible mindset and understand that what led to success in one era might not be repeatable in the next, you get these people that get really tripped up and frustrated.

If you go back to 2007, value investing was all the rage. Over the previous 10 or 15 years, value investors had smoked everyone else. This is when the Berkshire Hathaway annual meeting started getting really popular, because everyone wanted to be in value investing. And a lot of these value investors since 2007, over the past 12 years, their returns are terrible because value investing has just been so difficult over the past 12 years. What's worked is growth investing. Facebook, Amazon, Google,and whatnot. And a lot of these value investors, if you speak to them, I think are either in some state of denial, or they're just really confused and frustrated. They were so successful before, and then at the flip of a switch, that success stopped.

Southwick: When I started at The Motley Fool, there were kind of camps. It was like, "Bill Mann and Joe Magyer, they're value investors. Throw Mike Olsen on the pile, too." And there was, like, David Gardner, and they're the growth investors. And I think if you talk to Joe Magyer now, he'll be like, "Yeah, I'm no longer this hardcore value guy."

Housel: But, see, that's the personality that you want. You want someone who is able to change their mind when it's necessary. The people who are like, "I'm a value investor and I'm never going to change my mind," or, "I'm a growth investor and I'll never change my mind," those are the people that end up having trouble.

Southwick: I wish I could give Joe my money, but he's over in Australia.

Housel: Well, you can move to Australia.

Southwick: [gasps] Can I?

Housel: Sure, you have my permission.

Southwick: Cool, thank you! All right, next one: discounting the views of people who aren't as credentialed as you are, underestimating the special knowledge they have since they've experienced a world you haven't.

Housel: This is especially true, I think, in finance. In the upper echelons of finance, you get into investment banking and private equity. If you didn't go to an Ivy League school, if you didn't intern at Goldman Sachs, you're not worth speaking to. That's only a slight exaggeration. The flaw in that, of course, is that they get so insular in their views because they're only talking to people who went to the same schools as them, who were taught by the same bankers at the same bank through the same summer program as them, and they're missing the views of a lot of how the rest of the world works. People who didn't go to Harvard, who didn't go to Goldman Sachs, but have experienced a really important part of how the economy works. Whether they're from a different part of the economy, they've experienced different industries. The views of those people in aggregate are way more powerful and more influential than the group of views of the tiny, insular group that went to Goldman Sachs and Harvard.

I think where this is probably most relevant is in politics. After the 2016 election, a big part of the country realized that there's another part of the country that they were never really aware of --

Southwick: And they're a little angry!

Housel: -- that thinks very differently about the world than they did. And I think for a lot of people, for a lot of voters in 2016, that was a shock because they had only spoken to people, by and large, who were of the same general...they went to the same schools as them, they worked at the same companies as them.

Southwick: And we all agree! Isn't that great? Therefore, the whole country agrees with us.

Housel: Right, exactly! But I think that also exists in investing as well.

Southwick: Tom Gardner spoke in front of a group of people at The Fool this last week, Leadership Greater Washington. It's this group that David's involved in. And Tom's advice to everyone there -- and it's a group of a wide age range of people in D.C., who are...it's a leadership group...I'm butchering what it is that they actually do. But, anyway, networking, growing your skills, connecting, that kind of thing. And his advice to this group of people, who are all accomplished in their own way, is that they need to get a mentor that's younger than them.

Housel: I think that's great!

Southwick: That they need to find someone who can explain what the future is --

Housel: What's going on.

Southwick: -- because when you're older, you just get so locked down into your world and what you know, you forget that what you know is actually dying out with you.

Housel: 100%. My three-year-old son, this is no exaggeration, is more adept at using an iPad than my parents. Not even an exaggeration. And I think when you and I, Alison, are in our 60s, it's going to be the same thing. There's going to be things that 30-year-olds, 20-year-olds, understand that we just will not be able to wrap our heads around. As the world evolves, to be able to understand the views of someone who's seen a different world than you, has grown up with different values than you, is really important.

Southwick: Yeah. I feel weird about still going up to a...what's younger than millennials? Gen Y or something, are we calling them?

Housel: Gen Z.

Southwick: Gen Z, thank you! Gen Z. Wouldn't you feel weird going up to someone and being like, "Can you explain how the Snapchats work?"

Housel: I've done that at work.

Southwick: I've done it, too.

Housel: We have some Gen Z, and I've asked them tech questions.

Southwick: It's embarrassing.

Housel: It is embarrassing.

Southwick: [laughs] You just have to suck it up, I guess.

Housel: "Can you tell me how the Google works?"

Southwick: "What is the Google?" All right, next one: not understanding that in the classroom, the game is you versus the test; but in the real world, it's you versus coworkers, employees, customers, regulators, etc., all of whom need to be persuaded by more than having the right answer.

Housel: That's just like, if you're taking a test in school, as long as you calculate the right answer, you win.

Southwick: Don't care how you got there.

Housel: That's all you need to know. And if you're a jerk, if you can't communicate with people, it doesn't matter. You calculate the right answer, you're good. But in the real world, once you start working at companies, that's not the case whatsoever. If you are very talented at your skill, you're a great engineer, you're a great coder, whatever, but you're a jerk, you can't work with people, you can't communicate with people, you can't persuade people, it's not going to work. I feel like this happens a lot. Most of us have probably seen someone who was an absolute straight-A student at a great school, just off-the-charts intelligent, and they flounder in their careers because it's a very different skill that you need in the workplace than it is tested in school. But so much of our view of like, what is intelligence? It's your grades at school. But that doesn't necessarily translate to how well you're going to do in the real world. There's so many other skills that you need to know.

Southwick: Yeah. There's a saying. "The confused mind says no." The idea of, if you want to convince someone of something, that you have the right answer, you have to bring them on the journey. If you just present them with it, and they're at all confused, their first answer is going to be no. I'd be interested to hear, as you've gone on in your career, maybe what's one of the things you've learned for helping convince people? How do you do it? How do you communicate?

Housel: I think for a lot of things, it's your ability to tell a story that people can wrap their heads around. Even if you have the right answer -- let's say you're solving an engineering problem, and you know the answer. The answer is 2 + 2 = 4. But you can't just give people that equation and expect them to come along with you. You need to tell them a story about how you got there, why it's important, why this is going to make a difference, and explain it to them in a way that is compelling to them, that is short enough that you're going to capture their attention, you're not just going to ramble on with a 50-page PowerPoint. I think the power of storytelling is more important than almost any of the other skills that we think about that are taught in school. A lot of those skills -- math and science aren't effective unless you can tell a persuasive story around them. So I think if there's a skill that should be taught to a greater degree in schools, it's probably storytelling, which is this really soft -- like, when you say that, people probably think kindergarten. Telling stories? What is that? But all these other things that we learn aren't that effective unless you can tell an effective story around them.

A lot of the best writers of all time are people who, in their fields -- if they're mathematicians or historians -- are not the greatest, but they were very good storytellers, and because of that, they went to the top of the heap. My favorite example is Bill Bryson, who among historians, he's kind of a pop historian, let's say. Within historian circles, he's not looked upon that highly. If you're a hardcore historian from Harvard, or Stanford, whatever --

Southwick: It's like, "I didn't see you in the library."

Housel: -- it's like, Bryson is not really a historian. But he's such a good writer, such an amazing storyteller, that he's sold millions and millions of books. I think that's a perfect example. Another example is the book Sapiens. The author's name, I always have a hard time saying. Yuval Noah Harari. I'm probably butchering that, but I think that's it. His book, Sapiens, did not break any new ground about biology or evolution. Everything that's written in the book was already known. But he did such an amazing job telling the story that the book sold eight million copies. So, I think if you are a phenomenal biologist, or you're a tenured professor at Harvard studying evolutionary biology, you probably look at that and say, "This guy hasn't discovered anything, but he's the most popular." And the reason is because he's such a good storyteller.

Storytelling is one of those things that, unless you master that, all the other important skills don't really matter.

Southwick: Yeah, right. All right, and the final one: closed-system thinking. Underestimating the external consequences of your decisions in a hyper-connected world, or dismissing how quickly those consequences can backfire on you.

Housel: Like we were talking earlier, a lot of what goes on in investing is related to politics, particularly the triggers of recessions and bear markets and whatnot. So if you are an investor who says, "I'm not into politics. I'm just an investor, I don't pay attention to politics," I think that's fine, and it's fine if you're willing to put up with recessions and bear markets, which is a great attitude -- but the fact is that politics plays a big role in investing. If you're just looking at investing through the lens of finance, there's all these other forces that have a big impact on it. And if you're ignoring that, then you're probably going to have an experience that is vastly different from what you expect.

This is also true -- again, if you're an engineer, and you just think about a problem through engineering, but to succeed at your company, you also need to be adept at your company's politics, your internal politics, how to move up, how to persuade people, all these other forces that play a big role. If you get trapped within your own field and ignore everything else that makes a difference, it's hard to move ahead. It's a special kind of stupid.

Southwick: That is special. And then you close your article with, Bernie Madoff summarized this idea a year before his scheme unraveled?

Housel: Bernie Madoff, about a year before his quote-unquote "hedge fund" fell to the ground, did an interview. And this is on video, you can look it up on YouTube. And he said -- this is not verbatim. I don't remember what it was exactly, but it's pretty close to this. He said, "Investors don't understand that you cannot get away with fraud anymore. The SEC is too good at what they do, and if you are a fraudster, you will get caught."

Southwick: Crazy! [laughs]

Housel: Like, wow! That's Bernie Madoff saying that! There's so many different takeaways from that. Did he know he was going to get caught? Did he think he was the exception to the rule? There's all these different ways to think about it. But that's a really special form of stupid.

Southwick: Morgan, thank you again for joining us!

Housel: Thanks for having me!

Southwick: Listeners, you can get more Morgan at collaborativefund.com. He writes for their blog there. You can also follow him on Twitter at @MorganHousel.

Housel: Thanks for having me!

​Southwick: Come back again!