What can investors learn from the world of espionage?

What do spies and investors have in common?

Whether it’s weighing up foreign intelligence or toying with investment ideas, the answer is we’re all naturally influenced by certain types of information more than others.

The problem with this is that the most persuasive sources - those that really drive our decision-making - can be the most deceptive. So what’s needed are a few lessons from the world of spycraft to help understand the risk.

There are numerous sources of information when it comes to investment ideas. Some common ones are online chat forums, tip sheets, company presentations, meeting management, and the experiences of friends and family.

That might sound like a reasonable base of information, but the sources in that brief list all share a common feature. They all offer us something that we can either see or hear first hand, or engage in emotionally. In behavioural science, this is known as the Vividness Criterion. When we’re offered concrete, vivid information from sources like these, we can be heavily influenced by it.

The catch though, is that these sources of information range in usefulness from being bias to downright misleading. They often work to confirm our own views (confirmation bias) or just give us very little meaningful evidence to make a judgment.

By contrast, other sources of information like aggregate or statistical data (particularly numbers) are harder to remember and so we risk giving them less consideration. That’s despite them being much more useful in arriving at a balanced opinion.

This problem isn’t confined to investing. Back in the late 1990s, a CIA veteran called Richards J. Heuer, Jr. was so concerned about the way intelligence analysts could mess up their evaluation of evidence, that he wrote a guide for them. One of the main upshots - and this is a big lesson for investors - is not to overlook the importance of statistical data.

Seeing should not always be believing

Heuer’s book Psychology of Intelligence Analysis, pulled together a lot of the academic research into the ways people process information to make judgements. Part of it explored some of the common biases that creep in.

With the Vividness Criterion, Heuer picked up on research by Richard Nisbett and Lee Ross. His point was that analysts are faced with vast swathes of information, but they’re more inclined to value certain parts of it. In particular, he said, the events that people experience personally are more memorable - and more influential - than those they only read about.

This maps quite easily to investing, where company presentations, meetings and even bulletin board discussions risk providing a one-sided interpretation of a company or investment idea. That’s not to say they can’t be useful. But on their own, they offer nowhere near the sort of wide-ranging balance needed to make an informed decision.

Heuer didn’t stop there, either. The Vividness Criterion is so powerful it can quite easily override reasoned opinion based on statistical evidence. He explained this with the handy example of a Volvo...

To paraphrase Heuer… A man is about to buy a car. He overhears a stranger complaining about the how his Volvo is always breaking down. This may have as much influence on the buyer’s thinking as the statistics in Consumer Reports on the average repair bills for foreign-built cars. Yet that new information increases by one the sample on which the Consumer Reports statistics were based. In other words, it had very little value as evidence, but it had a very big impact on the potential car buyer.

Be careful who you listen to

Again, the read across to investing is clear. The views of bulletin board ‘authority figures’ (as Ed wrote about here), charming chief executives and forthright tipsters risk derailing good judgment.

In fact, from a Stockopedia perspective, our research shows that the most discussed shares on internet bulletin boards tend to have the lowest StockRanks in the market (which are a statistical analysis and ranking of their Quality, Value and Momentum). On average, historically, it’s this profile of share (weak, expensive and deteriorating) that tends to point to the worst performers. In addition, our own Paul Scott says that he has a self imposed 48 hour ban on investing in a company after meeting its management to stop him getting swept away in the emotion.

Indeed, Heuer wrote that “The most serious implication… is that certain kinds of very valuable evidence will have little influence simply because they are abstract. Statistical data, in particular, lack the rich and concrete detail to evoke vivid images, and they are often overlooked, ignored, or minimized.”

So from the world of espionage comes a lesson that investors should take to heart - be careful who you listen to. And don’t ignore the importance of statistical information like company financials. There’s no doubt that the wealth of information available to investors from a host of sources is a great thing. But our natural inclination to embrace vivid, emotionally-stimulating information can be a risk, too.