Thanks For The Memories

"Memory itself is an internal rumour."
-George Santayana, Philosopher

The bedrocks of professional investing — experience, judgment, intuition and deliberation — rely heavily on the use of memory. Though it is fundamental to learning and making effective choices, memory is also highly imperfect. While memories are sometimes cherished, they can push you toward investing misadventures. This essay examines how experts look at memory and its potential for generating investing shortfalls.

Motivated Memory

Memory. It reflects how information is captured, stored and retrieved. After an experience (visual, auditory, etc.), the brain chooses to capture information it finds interesting, useful or that stimulates strong feelings. It encodes this information into long-term memory that sits in the unconscious brain. Unavailable for probing and review, memory is accessed at the moment it is needed, either through conscious deliberation or with automatically generated decisions and actions.

Emotions affect both encoding and retrieval. Excitement about a series of great buys or pain from liquidation of deep losers can change how information is perceived, making it more vivid and stickier. Incorrect learning results from the encoding of such emotionally charged impressions. If such incorrect learning transforms into a deeply held belief, it can lead to repeated ineffective decisions.

Market turmoil and position volatility create stress and excitement. When present during the retrieval of memory, they limit the brain's searching, often pushing it toward simple and emotionally soothing solutions, rather than analyzing a more complete set of options.

Make My Memory

False memories may help explain why ineffective tendencies creep into otherwise sound investment processes.

Researcher Brian Gonsalves studied the formation of false memories using Functional Magnetic Resonance Imaging (FMRI) technology. Participants were shown images of objects and words and were asked to visualize the words clearly. Some of the words corresponded to the images others did not. According to Gonsalves: "Many of the visual images that the subjects were asked to imagine were later misremembered as actually having been seen." He points out: "A vividly imagined event can leave a memory trace in the brain that's very similar to that of an experienced event." Gonsalves and team were able to accurately predict when an imagined image would be remembered as having been seen because highly vivid imagination stimulates the same part of the brain as real experiences.

Memories can also be suggested, even impossible ones. Professor Elizabeth Loftus asked adults if they had met Mickey Mouse when they were children. Some were first shown a video of people having fun at Disney World. Recollection of this experience was significantly higher among those who saw the video. When in a positive emotional state, old and fragile autobiographical memories were unconsciously rewritten to include Mickey. To confirm this phenomenon, another group was asked about Bugs Bunny instead of Mickey. Among those shown the same Disney video, 16% recollected shaking hands with Bugs at Disney, even though he is not a Disney character, but a Warner Brothers creation. Interestingly, participants in both studies that viewed the video overwhelmingly denied it affected their recollections. Suggesting that not only is memory malleable but internal defenses refuse to accept this proven quality. Loftus concludes: "These studies show that with suggestion and imagination, a significant minority of people can be led to believe that they had experiences that were manufactured, and many of them elaborated upon those false experiences with idiosyncratically produced details."

Thesis, Process and Discipline Remembered

Despite its flaws, memory is all that many managers have for learning from their past decisions. Return and attribution help, but using them to improve is like a golfer playing at night using only the total score for feedback. Whether hitting above or below par, the golfer can't see where performance is strongest or where it needs refinement.

Left with only their memories, managers have no choice but to imagine where their alpha comes from. And this leads to missed opportunities regardless of the quintile they are in. Studies of actual portfolios show conclusively that:

• Strong buyers can and do consistently sell winners prematurely — giving away alpha in the process.
• Managers that pick great names often do not feed them sufficiently — reluctant to pay up for a stock on the run.
• Selling losers tends to be difficult — they are held longer than average and drag down performance.
• Winners often are held well past their productive lives, having secured a favored place in the manager's mind.

Ineffective decisions such as these can start with a faulty memory. Such memories may produce flawed beliefs and heuristics, which then are used to formulate and assess position thesis, process elements or specific disciplines. Critical analysis of skills and process is hampered as recollections reflect motivations as well as facts. You see only what your memories allow and your decisions integrate half-truths as if they were rigorously constructed data.

Conclusion

Memory defines who you are and what you think. It is, however, imperfect, fragile and quite capable of making falsehoods seem like facts. Memory recall ranges from consistent and complete to partial and irregular. As reliable as memories may seem, their flaws often lead to consistent poor decisions.

Incorrect learning or false memories tilt decisions toward ineffective choices and lower performance. Such Memories may be the product of weak encoding, retrieval or both. Comparing treasured recollections to facts is the surest antidote to ineffective memories. The alternative may position you as a prisoner of your past.

References:
1. "Neural Evidence That Vivid Imagining Can Lead To False Remembering", Brian Gonsalves, Paul J. Reber Darren R. Gitelman Todd B. Parrish Marsel Mesulam and Ken A. Paller, Psychological Science, October 2004.
2. "Make My Memory: How Advertising Can Change Our Memories of the Past", Elizabeth F. Loftus, Kathryn A. Braun and Rhiannon Ellis, Psychology & Marketing, John Wiley & Sons, Inc, 2002.
3. "Architecture of entrepreneurial learning: exploring the link among heuristics, knowledge, and action", Tim R. Holcomb, R. Duane Ireland, R. Michael Holmes, Jr. and Michael A. Hitt, Entrepreneurship: Theory and Practice, Jan, 2009.
4. "Motivated Reasoning", A Behavioral Matters essay, April 15, 2009, available at www.cabotresearch.com.