Behavioral Finance 101

Authority Bias:

The authority bias would always remain, more during bull markets. But in every bull market, usually the identity of the authority changes. I have always heard these things from the time I remember things about stock market. First such example I heard was “Harshad Mehta is buying Mazda, or Karnataka ball bearing or ACC.” And people will flock to buy these companies and this was back in the days of physical delivery of shares.

Next it was Ketan Parekh. And his TMT stocks. Some good, most not so good.

Others in authority category have been superstar investors like Ramesh Damani, RJ, Prof Bakshi, Kenneth Andrade, Ashish Kacholia, BM, Porinju and the list goes on.

The question we need to ask ourselves is “what do I know about the company?” besides the fact that X, Y OR Z holds it or recommends it.

I think it is pretty easy to overcome this bias. Once or twice we get hurt by following an authority, the learning is pretty obvious and if we dont take any cognisance from it, fault lies within us.


Doctors are exposed to this day in day out. Medical reps tend to give small brand reminders, samples, and many more inducements to doctors in a effort to get prescriptions of their products.

Similarly in stock markets too, some shady investors we meet for first time or for first few times tend to come with various “gifts” in forms of chocolates, books, or any other form of inducements. Many do so with goodness of heart and do so to offer a token of gratitude or respect but there will always be some trying to get some information/stock picks or providing us with disinformation in an effort to manipulate stock prices.

This again can be dealt with easily by asking ourselves “Why is this guy so generous towards me?”

I think incentive bias is rampant in all walks of life and can often be used to open some gates which normally do not open easily.


Perhaps relevant to the on-going discussion about biases:

18 Key Behavioral Finance Biases

My favorite bias to talk about is Loss Aversion. This is even quite relevant to the current market situation.

There have been several experiments centered around Loss Aversion, but I will elaborate briefly the experiment conducted at Yale in 2005. The Cebus apella , or the South American Capuchin was chosen for the experiment.


The research began by introducing the monkeys to flat, circular ‘discs’. The monkeys were given food whenever they gave the experimenters a disc. Slowly, the monkeys were introduced to the concept of ‘money’. This went on for a while until the monkeys were comfortable trading the ‘money’ for delicacies such as Apples, Grapes and Jelly, all of them priced at ‘1 disc’.

The actual experiments then began. This was done in three installments to test the behavior of the monkeys under different risk-reward scenarios:

  1. First Installment: Person A would give the monkeys 1 piece of food for 1 disc without fail. Person B would give the monkeys 2 pieces of food for 1 disc, but half the time he would give only 1 piece per disc. The monkeys soon worked out that the expected food from Person A was 1 piece per disc and from Person B was 1.5 piece(s) per disc. They learned to prefer Person B to Person A very soon.
  2. Second Installment: Person B’s behavior remained the same. He would give 2 pieces per disc, but half the time he would give only 1 piece. However, Person A would now, half the time, hand over a free bonus piece once the discs have been given to him. In this case, the expected outcome is identical: 1.5 piece(s) per disc. However, since Person B actually ‘cheats’ the monkeys and Person A ‘rewards’ the monkeys, they came to prefer Person A to Person B this time around, exhibiting some aversion to loss.
  3. Third Installment: Person A only ever gave 1 piece per disc. Person B, however, would give 2 pieces per disc, but immediately take away a piece before the monkeys could eat them. In this case again, the expected outcome is 1 piece per disc across the board. But Person B ‘takes away’ a piece, while Person A does no such ‘cheating’. Not so surprisingly, the monkeys came to prefer Person A to Person B heavily. This was concluded as a clear case of Loss Aversion exhibited by the monkeys.

Human Beings aren’t so different. One possible explanation of this phenomenon is that by nature, humans and other primates feel the pain of loss much deeper than they feel the pleasure of victory. Hence, they prefer avoiding losses to making gains, even if the magnitude of losses and gains are the same.

What this means for investing is that the average investor loves to make gains, but is extremely terrified of facing losses. The average investor is easily spooked by rumors, deep corrections and bad short term metrics. This is, however, is great news to the rational investor. The rational investor should get busy buying when the market over-reacts to a rumor or a quarterly/annual result. Loss aversion is a pointless behavioral bias in investing, one that should be avoided religiously.

In line with this behavioral finance bias, a classic Value Investing example I love discussing about is the purchase of the Burlington Northern Santa Fe (A private railroad company) by Berkshire Hathaway around the end of 2009. The WSJ wrote this article after the purchase: Warren Buffett: Buying Near the Bottom … Again. Other investors and ‘financial analysts’ were critiquing Warren Buffet, saying that the old man had lost his game, going around buying out railroad companies during a recession. But that’s precisely why Warren Buffet bought BNSF — it was available during a recession, with dwindling profits and at a rock-bottom price of $100/share. This was a company which had shown tremendous business results in the past, but was momentarily handicapped by the recession. Warren Buffet knew that, eventually, the economy will revive and companies would then want their raw materials transported. And guess what, it happened. This is the P/L of BNSF for the 4 years following the purchase, taken from a research article by Barclays Research:


Since the company is privately-held by Berkshire Hathaway, nobody really knows its value, but a rough estimate shows that it’s given at least a 15% CAGR in all the following years. The purchase of BNSF by Berkshire Hathaway under Warren Buffet is the embodiment of the Value Investing philosophy and a proof of concept of his own famous quote “ Be greedy when others are fearful.

Brian Barish once said “ The ability to scare the hell out of people is much greater than the ability to attract them to equities. ” How true is that!

Disclaimer: The above post has been reproduced verbatim from my earlier Quora answer.


Mental Model 6

Honesty & Integrity

Mr Munger has quite a few things to say on honesty. Let’s go through a few of them.

“I think track records are very important. If you start early trying to have a perfect one in some simple thing like honesty, you’re well on you way to success in this world.”

“Remember that reputation and integrity are your most valuable assets – and can be lost in a heartbeat.”

"Hard work, honesty, if you keep at it, will get you almost anything".

This is not an easy policy to live by. I have been personally tested on it many times and at the risk of sounding pious, which I am not, I will share a story with you.

The business domain I am in is known for rampant bribery. When we opened our business we made a policy; We will not pay any bribes. Period. But for the first year or so after we started, I was constantly pressured by my sales team, sir, this order, that order, if we pay something we can get them; and I kept sticking to my policy of no bribes.

But as is always the case, your rules and your policy of honesty will be properly tested. One day, we get a buyer who is willing to place an order for around 6 Crores on which I am going to make 30% so 1.8 Crore and he wants 3%. (I have converted the money into INR as the deal was not in INR).

The minute my sales manager asked me what to do, I said, you know my answer; we will not bribe. She smiled and said, yes, I knew that will be your answer so I already told them to take a walk.

We lost the order but we kept our soul intact.

Now, years later, we have the top organizations including consulates, MNC’s and many government organizations buying from us, and I found to my surprise, honesty is also a niche one can operate in. I mean when everyone else is bribing, if you don’t bribe, you have found a niche market.

Today I better understand what Mr Munger and Mr Buffett meant when they said “More often we’ve made extra money out of morality. Ben Franklin was right for us. He didn’t say honesty was the best morals, he said that it was the best policy.”

Today we have a business full of people who are honest and who we can trust. It starts from the top.

And there will always be consequences of consequences. So, my employees know they work for an honest business, so they also conduct their affairs accordingly. If a company’s managers or owners are bribers and cheats, why would the employees not learn that if it’s ok to cheat for the company, then it’s also ok to cheat from the company? Then these business owners should not be surprised that these people whom they have asked to defraud and cheat others, one day do the same to them.

Do we not in stock markets pay a put a high premium on the Nestle’s and Asian Paints of India? Why? Because over the years, they have proved themselves honest in their conduct with customers, with suppliers and with shareholders. So then, how is it that some people expect the world to be honest to them, but they themselves are not?

I hope this makes some sense to some of you who read this. In investing as well, this is one of the first needed filters when screening a potential company where you want to partner with the majority shareholders and you will be a minority shareholder. Your success will depend upon the direction of their moral compass.

–End for today


Mental Model 7

Inner Scorecard vs Outer Scorecard

Before I go ahead, I thought of sharing a small tidbit.

There are so many fans of Mr Warren Buffett and follow him, read about him, discuss him but forget to listen to Mr. Munger. Almost as if he did not exist. Most don’t make the connection that Mr. Munger is Mr. Buffet’s business partner, and has been so for around 50 years. They have done this together. So for value investors, the equation could be; Warren Buffett = Warren + Charlie.

Ok, back to inner scorecard. This model is provided by Mr. Buffett.

He asked, “Would you rather be the world’s greatest lover, but have everyone think you’re the world’s worst lover? Or would you rather be the world’s worst lover but have everyone think you’re the world’s greatest lover?”

Here’s one more; “If the world couldn’t see your results, would you rather be thought of as the world’s greatest investor but in reality have the world’s worst record? Or be thought of as the world’s worst investor when you were actually the best?”

Also, “The big question about how people behave is whether they’ve got an Inner Scorecard or an Outer Scorecard. It helps if you can be satisfied with an Inner Scorecard.”

The core idea is that most people live their lives with an outer scorecard and not an inner scorecard.


-People taking selfies to post on social media whenever they go out. They want to tell the world they are having a good time more than actually enjoying themselves and actually having a good time.

-People basking in admiration when someone tells them they are looking nice, have lost weight etc… I mean, don’t get too happy, just go and check the fact on the weighing scale. The truth is the weight is probably the same as last month and so is the belt size :slight_smile:. But people love lies no?

-Humans have a deep desire for admiration of other people. They want and dream of applause from the world. Much like the TV singing competitions, where new people are bought up on stage every year, and told every week that they are the next Asha Bhosle or Lata Mangeshkar :slight_smile: They love it. Most of us too would love it.

-People want praise. Waah, you are so smart. Wow, you are so intelligent. etc.

-People buy expensive clothes to impress others when they go out. Society is programmed such that, for example at a wedding the woman with the most jewelry is number 1; or for example, 5 acquaintances go out for dinner, and on the way out they are checking out the car the other person came in. Now if you came in a small car, you will feel a slight sweat on your brow. You are embarrassed. Funny, you are embarrassed of yourself? Why?

Why do I need to be told whether I am smart or not? Why do I seek this recognition? Why do I want the adulation and applause?

Now, if I was living with an inner scorecard instead of an outer scorecard, I would not be asking for points from the world. I would be checking off my inner scorecard to see if I am good, smart or whatever else.

So if shallowness stops being the source of one’s existence, then true existence might be felt. It will come from inside. Whenever one does something, or before or after doing something, they will check with their inner scorecard.

For sure, they will probably live a happier and calmer life, but let me tell you a secret; they will also have more money because they didn’t use their credit card to pay a bill to impress people who they will probably not even meet 10 years down the line :slight_smile: We could all do with trying to impress others less.

Live for yourself. Impress yourself. Not the world.

–End for today


Very well written. :ok_hand:
There is a popular book on this topic which I feel is worth reading.


Apologies in advance if the below poem does not resonate with the feelings of others as it does with mine.

I find the last para of Tennyson’s Ulysses, really moving whenever challenging times get me down. Here is hoping, that it will do the same for some of you, both in investing and in life outside.

Tho’ much is taken, much abides; and though
We are not now that strength which in old days
Moved earth and heaven; that which we are, we are;
One equal temper of heroic hearts,
Made weak by time and fate, but strong in will
To strive, to seek, to find, and not to yield.

The movie buffs will notice it is the same poem, recited by M in Skyfall.


To the few who were reading here: I am truly so sorry but I for personal reasons I have to stop logging in to VP effective immediately. I really had hoped to take this subject to completion, so I apologize.

However, I know two things; One, If you got this far, you already are well ready to explore this subject further on your own. Which leads me to the second point which is that you are “almost there already” if you got to this point of reading this thread.

To explain that better, here is an article in which Mr. Munger has said on a book on him, which I now recommend to you “Poor Charlie’s Almanac”; about which he says "If you read the book, sure, you’ll be more likely to get rich, Munger said. But it’s not a get-rich-quick manual. Indeed, the book isn’t for everyone, he warned. It’s for the people who are almost there already, who just need a nudge in the right direction. “These people who love that book are in the few people who can be taught,” he said. “Most people have no hope of being improved by ‘Poor Charlie’s Almanack,’ or anything else.” You can read this article here:

Before I go however, I am pasting below a few books that should help in your journey into Behavioral Finance.
Book Recommendations;
Poor Charlie’s Almanac
Poor Richard’s Almanac
Value Investing and Behavioral Finance - Parag Parikh
Your Money & Your Brain - Jason Zweig
Where are the customers Yatchs? - Fred Schwed
A Random Walk Down Wall Street - Burton G Malkeil
Extraordinary Popular Delusions and Madness of the crowds - Mackay
A Man For All Markets - Edward Thorpe
This Time It’s Different - Reinhart & Rogoff
Influence - Cialdini
Pre-suasion- Cialdini

All these above might end up costing you 10 to 20 thousand rupees but I firmly believe that they will pay off 100 times over.

I home some of you here will take the thread forward.

Best Regards,

Changu Mangu.


Prof bakshi, What books would you recommend on the above on the concepts you mentioned in buddhism or jainism or other such reference? Thanks

It’s an awesome book. What other sources do you recommend for Charlie Munger as I too am a big Munger fan like you .
Also want to reread the book however find it pretty hard to read as it’s very heavy . Is there a ebook version available somewhere as I couldn’t find it on Amazon?

Hi All

Of the many books on behavioral sciences, the one i liked the most till date is ‘Predictably Irrational’ by Dan Ariely.

i had made some notes on the same that i had written in the below blog link -

hope this helps!


Goodbye Charlie Munger.

Your influence has been immense.

Two quotes, which I hold dear; especially considering my many stupidities in investing and more when I migrated to trading for a period;
If you’re not failing, you’re not improving.
“Of course, there’s going to be some failure in making the correct decisions. Nobody bats a thousand,” Munger said. “I think it’s important to review your past stupidities so you are less likely to repeat them, but I’m not gnashing my teeth over it or suffering or enduring it.”

“I think the tragedy in life is to be so timid that you don’t play hard enough so you have some reverses,”.

Goodbye Mr Charlie.

You will be an influence to me all my life.