Looking for the Next Amazon – Why Bother?
Diving into possible motivations when investors take off-beaten paths. By Benjamin Tan
Studying human psychology as part of my master’s program in clinical mental health has brought me closer to various theories explaining human behaviors.
For example, in Kohlberg’s 6 Stages of Moral Development, we learn that individuals can operate at any of the following levels when they contemplate moral dilemmas:
Punishment avoidance
Self-interest
Social norms - to fit in and look good
Conformity to authority and social order
Social contract orientation - for the greater good
Principles-based
Lower and Higher-Level Thinking
Thinking at lower levels – such as avoidance of punishment (Level 1) and self-interest (Level 2) – is associated with a more rudimentary style of reasoning. Children can only operate at these levels because of their limited cognitive abilities at earlier stages of brain development.
On the other hand, higher-level thinking – such as social contract-driven (Level 5) and principles-based (Level 6) – is far more advanced. It requires one to hold multiple perspectives and reason abstract concepts based on principles.
Elon Musk: First Principles
Readers may recall that Elon Musk often refers to “first-principles thinking” in interviews. In a Rolling Stone story back in 2017, Musk outlined his scientific approach to solving hard problems. While he is a controversial figure, few can dispute his technical mind that led to ground-breaking innovations, most visibly with Tesla and SpaceX.
Consider the below quote from Elon Musk on first principles thinking:
“Don’t just follow the trend. You may have heard me say that it’s good to think in terms of the physics approach of first principles. Which is, rather than reasoning by analogy, you boil things down to the most fundamental truths you can imagine, and you reason up from there.”
What Musk describes above is akin to Kohlberg’s Level 6 thinking.
High-Level Thinking is Tough and Rare
Kohlberg observes that only 10-15% of people can reach Levels 5 and 6, even though these reasoning skills should be part of adulthood. And there is no skipping of stages: if one is still motivated by peer approval (Level 3), one cannot operate at Level 5 or Level 6.
Looking for the Next Amazon or Apple - Why?
This makes me wonder why investors choose stock-picking over diversified index funds. Even more curiously, why do some investors study obscure names to uncover the next 100-bagger? After all, based on Kohlberg’s theory, most of us do not possess the cognitive skills to think at advanced levels and rise above the crowd.
I am guilty on both counts. I do have individual positions, and I have invested in smaller capitalization companies. Looking back at my decade-long investment record in Asia, I note that my market-beating results were all attributable to larger REITs that I invested in my later years of living there rather than the smaller companies I initially obsessed over. Consequently, in America, I am now far more inclined to invest in larger companies, index funds, fixed-income instruments, and real estate because I do not know what I do not know. I know my intellectual high horse can become my Achilles heel.
When trying to bet on the next Amazon (AMZN 0.00%↑) and Apple (AAPL 0.00%↑) , it is worth noting that we may not be as rational as we believe, let alone think at Level 6 (principles-based). It is possible that our blind spots are leading the alpha hunt, rather than higher-level reasoning skills.
Going back to the series of Enneagram articles that I had written, below are the nine personality types and possible blind spot(s) for each when trying to beat the market:
Type One: Adherence to valuation ratios leading to value traps. There could be a mix of Level 1 (avoiding the punishment of higher prices) and Level 4 (conformity with the rules of value investing) thinking involved with this personality type.
Type Two: Hubris, perhaps. An example is investing in AMC 6.48%↑ to help the company fight the Wall Street skeptics. There may be an element of Level 3 thinking here.
Type Three: Jumping on investment bandwagons. This is akin to Kohlberg’s Level 3 thinking.
Type Four: Emotionally charged decision-making combined with envy. This is likely to be infused with a pre-conventional style of reasoning - Level 1 and 2 thinking - given the inner orientation of this personality type.
Type Five: Overconfidence in intellectual horsepower combined with head in the sand mentality. Like Type Four, thinking may be more influenced by lower-level reasoning than principles-based, even though many Type Five may prefer to believe in the latter!
Type Six: Skepticism in allowing simplicity. Levels 1, 2, and 4 thinking are likely in the picture here.
Type Seven: Blue sky thinking, perhaps driven by punishment avoidance (Level 1) and self-interest (Level 2).
Type Eights: Raw ambition, likely motivated by strong self-interest (Level 2).
Type Nine: Going with the flow, akin to a combination of Levels 2, 3, and 4 thinking.
Why Learning About Our Motivations Matters in Investing
Our best traits and core motivations are often accompanied by closely related blind spots and unhealthy biases. Therefore, it is important to clarify our primary underpinnings for investing because they can reveal the specific personality pitfalls we face as investors. When large sums of money are involved, emotional temperatures are raised and this can lead to obscured thinking.
I will be sharing more of my learnings in psychology and personality typologies as part of a master’s program in clinical mental health within the context of investing. Do subscribe to join me on this journey:
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