How the ability to change perspective helps an investor preserve capital

The ability to take back what you say is not always a matter of strength or weakness of character. For an investor, it can also be a matter of saving capital. This is evidenced by a study published in the journal Cognitive Research: Principles and Implications. It showed that people with a mobile intelligence are much easier to abandon false beliefs. How can this study be useful in the financial markets?

Specialists from the Julius and Maximilian University of Würzburg for the 2024 study gave participants a news text about a pilot project in an Estonian tech company. In one version the material was neutral, in the other version it contained misinformation: allegedly the employees' free schedule led to a drop in their efficiency and financial losses for the organization. Later, some respondents were given a corrected message explaining that the company's losses were not related to the working hours, but to the expiration of contracts, and that the pilot project was generally successful.

Next, the researchers measured how people's attitudes toward the information about the free schedule changed before and after the rebuttal. The picture turned out to be twofold: on the one hand, the clarifying message on average improved attitudes toward the work mode. This was the "correction effect," the researchers thought.

On the other hand, the trace of misinformation from the original news did not completely disappear, and some participants in the experiment still had the so-called "continued influence effect. This is when the original information continues to influence judgments and decisions even after it turns out to be false.

It turned out that people with higher logical reasoning ability were markedly more likely to revise their opinions after a rebuttal than participants with lower cognitive ability.

The authors concluded that fluid intelligence helps to better integrate new information into existing cognitive schemes. A person doesn't just learn a new fact, he or she builds a logical connection: "If this turns out to be wrong, then perhaps my whole previous view needs to be revised.

The German scientists linked these results to an earlier study about the "need for cognition". This is about the habit of thinking a lot, while mobile intelligence and willingness to change opinions are about the quality and flexibility of these thinking operations. That is, a person can like to think, but stubbornly not revise their beliefs. And a more agile mind can more easily update cognitive schemas to fit new data. This is exactly what happened in the German study.

The investor is somewhat like the participants in the German experiment: he can see that his initial perceptions and forecasts about an asset did not work out to the plus side, and then relatively quickly update the model - revise the weight of this asset in the portfolio or completely withdraw from it.

In contrast, an investor with a less flexible cognitive system is subject to the effect of continued influence: the original version of events, on the basis of which he makes decisions, remains in his mind. New facts are interpreted more as "noise" or a temporary anomaly.

If we follow the logic of the German psychologists' study, the key advantage of an investor is not the ability to guess or even predict the market trajectory or the price of an asset, but the ability to "retool" as quickly as possible when assessments and perceptions diverge from new data. This is something that Warren Buffett has essentially emphasized repeatedly: when fundamentals change, an investor must be willing to change his or her mind.

The first step is formalization. For each investment idea, it is worth fixing initial assumptions and forecasts: the company's revenue and margin dynamics, regulatory regime, cost of capital, and competitor behavior. Such a "profile of the investment idea" makes the picture more visual, so when something in it changes, it becomes clearer faster which element is broken.

This is in many ways in line with Warren Buffett's words that "you should buy businesses, not shares". In his letters to shareholders, he systematically describes the criteria for buying a business: quality of management, understandability of the model, intrinsic value, reasonable price, i.e. he actually works with a set of assumptions, if they are violated, the business ceases to suit him.

The second step is to set criteria for reviewing an investment idea or principle. These should be expressed in numbers. This can be, for example, a specific debt threshold, three consecutive weak financial reports of the company, and others. At the level of cognitive processes, this reduces the effect of emotions and the resistance to change caused by them: the decision is activated as if by the rules, rather than being submitted to an internal "psychological judgment".

Finally, in light of the findings from the German study, it may be useful to specifically train "rebuttal seeking". People who are actively involved in checking sources and looking for alternative data are better protected from the effects of continued influence. This means regularly reading not only optimistic research notes, articles and reviews that talk about the growth of an asset or market, but also examining alternative and even contrary data.

It is also helpful to regularly ask yourself the question, "What would have to happen for me to admit I was wrong?" The answer can be either changes in the market or specific events related to the company in which you invested.

This article was AI-translated and verified by a human editor