Everybody thinks they are excellent at learning. After all, most of us have gone through years of university education and got one or more bits of paper showing just how good we are accumulating knowledge. Acronyms after our names often appear just in case society forgets the value of this knowledge.
However, it is learning from past errors (or mistakes) that interests me. Here the evidence is compelling: we aren't good at understanding our mistakes. In fact, we generally don't even acknowledge that we have made mistakes, let alone going on to learn from them.
Our minds have a gamut of mental devices that can be deployed to protect us from the ugly reality of our poor decision-making. Four hurdles in particular stand out. First is self-attribution bias. We have a relatively fragile sense of self-esteem; one of the key mechanisms for protecting this self image is self-attribution bias. This is the tendency for good outcomes to be attributed to skill and bad outcomes to be attributed to sheer bad luck. This is one of the key limits to learning that investors are likely to encounter. This mechanism prevents us from recognizing mistakes as mistakes, and hence often prevents us from learning from those past errors.
Hindsight bias is a second oft-used mental defence mechanism. Hindsight bias refers to the fact that after something has happened we are all really sure that we knew it would happen all along.
Once people know the answer, they find it impossible to imagine any other outcome. As with self-attribution, hindsight blinds us to past errors. Orwellian rewriting of history becomes the norm. Simply warning people about this bias has little effect.
Explicitly, asking people to think about other alternative outcomes has more impact. Written records of previous beliefs can also help offset this bias.
Our world is inherently probabilistic. That is to say; we live in an uncertain world where cause and effect are not always transparent. We have a habit of believing that we can control events far more than we can. Thus we attribute outcomes to our actions, even though they may well have nothing to do with us. The illusion of control is particularly prevalent when lots of choices are available, you have had early success at the task, the task is familiar to you, the amount of information is high and you have a personal involvement. Large portfolios, high turnover and short time horizons are the financial equivalents of these conditions.
The final major hurdle in learning from our failures stems from our ability to twist the facts to fit our own beliefs. So if we get on the bathroom scales and they show us we have gained weight, we get off and try again, just in case we were standing strangely.
However, if they gave us a pleasant surprise we would accept it and skip off to the shower. We go through life in much the same fashion, accepting feedback that agrees with us, and scrutinising any that disagrees with us. Once again; this prevents us learning from our errors.
Another, related effect: humans exhibit confirmation bias when they tend to view all new evidence through the old lens of their existing beliefs. They disregard whatever might tend to disprove what they already believe, even while they point eagerly to any information that reinforces the views they already hold.
Understanding these biases are useful not only to investors but to the general public as we are all susceptible to these fallacies. Take for instance how parents react to children on receiving their exam results. Good results are rewarded with gifts, while poor ones are sometimes harshly punched. Parents spend little time in trying to decipher whether the result was down to pure skill (which deserves rewards and recognition, as long as they are not high-fat, high-sugar treats!) or luck (deserving a far more nuanced reaction). The same applies to our views on the success and failure of others.
Some of these behavioural problems can be countered by keeping written records of decisions and the 'logic' behind those decisions. But this requires discipline and a willingness to re-examine our past decisions. Psychologists have found that it takes far more information about mistakes than it should do, to get us to change our minds. So little wonder that learning from past mistakes is a difficult process. However, as always, being aware of the potential problems is a first step to guarding against them.
(Kajanga is an Investment Specialist based in Sydney, Australia. You can write to him at