Posted by Mindset, mindset, mindset… I’ll never get tired of talking about it.
Every aspect of your life comes down to your mindset – how you think, feel and react to events at any given moment.
But when it comes to property investment, you can have a positive, growth mindset and still get caught short. So how can you avoid that? A lot of it comes down to experience, the wisdom that comes from making, and learning from, mistakes, obviously, but a lot of it also comes from properly understanding cognitive bias.
I’ve spoken about this many times before, but I do think it is worthwhile revisiting. Fully understanding the thinking traps that you might unwittingly be falling into is once of those things that can help your investing approach move from amateur to professional.
What is cognitive bias?
Simply put, cognitive bias is a thinking error that occurs when people process or interpret information. Often, it’s because our brain is trying to take a shortcut, so it refers back to similar past experiences.
Your brain automatically looks for repeat patterns, things it has done before, or for things that seem logical, that seem familiar and seem correct. As a result, you might find yourself making ill thought-out decisions that can cause you problems further down the road.
So, what should you be looking out for?
Authority bias
Authority, or framing bias, happens a lot. People make decisions based on where they’ve received information from.
Say you’re sitting at a restaurant and overhear the people at the next table talking about the stock market. You can’t help but hear them talking about a particular stock that’s definitely going to go up in the market, and how it’s a great time to buy it.
The next day, you’re walking down the street and a homeless guy is asking for money. As you’re rummaging through your pocket for some change he says thank you very much sir, I’m going to give you a stock tip, you should go and buy shares in this company, it’s going do really well,
You thank him and walk away, thinking nothing of his ‘tip’, but after a minute you realise that it’s exactly the same information you heard the day before.
The man in the restaurant was well-groomed, of a certain age, wearing a sharp suit and talking to other business people. In short, he seemed like he would know what he’s talking about. Because the other information came from a guy on the street you automatically assumed it wasn’t valid.
If the information is identical, why do you give more authority to the man in the fancy restaurant over the homeless man?
It’s because you’ve framed it a certain way coming from one individual versus another. The person who gave you it is the reason that you’re valuing one over the other. That’s authority bias.
Now, the correct thing to do is to ignore both and to go away and do your own homework. Don’t abdicate your decision making to another person, no matter who they are or how they’re dressed.
Confirmation bias
Next on my list is confirmation bias. This is quite a dangerous one because it’s very easy to fall into this trap. I know, I’ve done it myself!
Confirmation bias is when you subconsciously seek out information or data that confirms a decision you have already made. Let’s use my deal in Spain as an example: I saw a site and I had an idea. I liked this location and I loved my idea to build a big luxury shopping complex.
The truth is, I had fallen in love with the idea of this deal long before I had any information to back up whether it could work or not.
I spoke to my lawyer in Spain, who thought it was a great idea. I spoke to the people who were selling me the property, who told me it was a fantastic idea. Then I spoke to property advisor who said he wasn’t so sure about it.
So what did I do then? Sad to say, I ignored him and I found another advisor, who told me it was an amazing idea. Fast forward a couple of years and the deal was a complete meltdown.
I had decided I wanted to go ahead with it all long before I had the evidence to support the decision, so I was looking for evidence to support what I had already decided to do, rather than the other way around.
Continuity bias
Continuity bias is the tendency to disbelieve or minimise threats or warnings because your default mindset is that whatever the current status quo is, that’s how things will continue.
This works both in a positive way and a negative way: think about how in 2020, in the middle of COVID, interest rates were very low and started to get even lower.
Suddenly, after lockdown ended, there was a rush to buy property – why was that? It was because of those low interest rates. People saw them hovering around zero and thought the rate environment would continue for a prolonged period of time.
I remember having a conversation with an investor at the time who said he saw no circumstances in which interest rates would could increase…And as we know, along came inflation and interest rates have since gone up something like 5% in that period.
Never assume that the status quo that you’re currently in will continue, and always plan for the worst.
Survivorship bias
Survivorship bias is the tendency to listen to the insights and opinions of survivors or successful people.
This is one of the reasons why you go into the biography section of a bookstore, you’ll see biographies on Steve Jobs, Richard Branson, Mark Zuckerberg, Jeff Bezos… the list goes on. Name the business icon and there’ll be a book about that person, because they’re successful. They have survived in the business arena and they’re able to tell the story of how they did it.
Have you ever gone out and bought a book from an author who suffered a devastating loss, who went out and tried to start a business and the whole thing collapsed and he lost his family home?
Most people aren’t interested in reading about the losses or the mistakes. They want to read the kind of inspiring story about how a 20-year-old can go and become a billionaire. But the reality is that if you go and read the story of somebody who tried very hard and lost it all, you’re going to find more valuable insights.
When you’re reading a book about somebody successful, remember that they’re not going to tell you the stuff that went wrong for them, and you’re not necessarily going to learn as much from them, no matter how much of an inspiring read it might be.
Restraint bias
Restraint bias is the tendency to overestimate your ability to show restraint in the face of temptation. When somebody comes along and offers you a get rich quick scheme next year or next week, it can be hard to look the other way.
If someone is waving money in front of your face, saying you can be rich one week from now if you buy this stock, it’s going to make you rich! Of course, you don’t want to miss out, you want to ride that train as well, and so sure enough you jump in.
The problem with a lot of these stocks and share is that there’s no underlying fundamental reason for their prices to go up.
It’s in a hype cycle, you’re buying it from somebody, they’ve made a profit selling it to you, and you’re hoping to make a profit selling it to somebody else. As long as it keeps getting hyped, you’re always going to make some money. But the problem is the hype stops at some point.
Be careful of jumping in to an opportunity a little bit too quickly, just because you’re not as good at showing restraint as you thought you were.
Disposition bias
The last one on my list is disposition bias. This is probably the best one to describe for property investors because this is one I’ve seen displayed a lot. Disposition is the tendency to prematurely sell assets that have made financial gains, while holding on to assets that are losing money.
Let’s say you buy two properties and you pay 100k for both. A year later, one has fallen in value and is now valued at 75k and the other has risen by 50% and is now worth 150k.
You’re up 50k on one, you’re down 25k on the other, and you have to sell one. Which do you choose? The vast majority of people will turn around and say, that’s easy. I’ll sell the 150k. I’ll take that 50k profit and put that in my pocket.
That’s might sound logical enough, but the reality is that most people just don’t want to crystallize the 25k loss.
You have to look at the assets themselves and try to figure out what is driving the price rise and the price fall in both cases. Most people will sell the 150k just because it’s gone up, not because of the underlying reason why it rose. Just as it’s gone up, the other one’s gone down.
That’s the rationale, but who’s to say that a year later it wouldn’t rise to 250k or 300k, whilst the property that’s languishing at 75k might stay there? Sometimes you buy something and it does badly and that has to be accepted as a risk as an investor.
The best thing you can do is accept the loss, sell that 75k, get the money back and put it into something that will perform more like the 150k.
A lot of the time, disposition bias will force you to think that the right one to sell is the one that’s winning, where in fact, it could ultimately leave you out of pocket and with an albatross around your neck.
I hope you’ve found this useful! I took a deeper dive on this topic in Episode 206 of the podcast, with some extra thinking traps not mentioned here, so do take a listen!