Take The Base
And remember where you came from...
As we continue to explore the ways our brains can lead us astray in the investment world, two powerful biases demand our attention: Base Rate Neglect and the Availability Cascade. Understanding these tendencies is crucial for navigating the market with a more rational and less emotionally driven approach but are another example of how we're wired to be bad at investing.
Base Rate Neglect: When Stories Trump Statistics
Imagine the allure of a promising mining explorer, led by an experienced geologist and sitting on what appears to be a world-class deposit. The drill results are exceptional, the geological reports are compelling, and the potential returns are seemingly limitless. This is where Base Rate Neglect can take hold. This bias describes our tendency to ignore general statistical information – the "base rate" – in favour of specific, often anecdotal details when making judgments. We become so enamoured with the unique story that we overlook the fundamental probabilities of success for most mining explorers in general.
Consider the sobering reality: fewer than 1% of mining exploration projects ever become profitable operating mines. Even projects that show initial promise face a brutal gauntlet – only about 10% of exploration projects advance to feasibility studies, and of those, roughly half never make it to production due to economic, environmental, or technical challenges. Yet when presented with compelling drill results, experienced management, and promising geological surveys, we mentally file away this inconvenient statistic. The human brain is naturally drawn to vivid, specific information over abstract numbers. A geologist's excitement about rare earth deposits feels more "real" than dry mining industry success rates.
This bias extends far beyond mining exploration. Take stock picking: while the base rate tells us that roughly 80-90% of actively managed funds fail to beat their benchmark over long periods, we're still drawn to fund managers with compelling track records or persuasive investment philosophies. We focus on the specific manager's credentials rather than the overwhelming statistical likelihood of underperformance.
As Daniel Kahneman aptly put it in "Thinking, Fast and Slow":
"When base-rate information is weak, and other information is concrete and diagnostic, people ignore the base rate."
The compelling narrative of a particular investment often feels far more tangible and convincing than the abstract statistics of overall mining exploration failure rates. Our brains are wired to process stories more readily than statistics – it's an evolutionary feature that now works against us in modern investing.
Real-World Examples
During the dot-com bubble, investors repeatedly ignored the base rate of technology company failures, instead focusing on specific stories of revolutionary business models and "new economy" paradigms. Each failed dot-com was dismissed as an exception while the compelling narratives of the next wave of companies captured attention.
The mining sector provides an equally compelling example. During commodity booms, investors regularly ignore exploration failure rates, instead focusing on specific companies with exciting drill results or promising geological formations. The lithium boom of recent years saw countless exploration companies attract investment based on early-stage projects, despite the brutal reality that most would never produce a single ounce of commercially viable lithium.
To counter this, disciplined investors actively seek out general statistics, remain sceptical of "this time it's different" narratives, and constantly ask: "What are the actual probabilities?" They maintain what Charlie Munger calls "base rate respect" – always starting with the fundamental odds before getting seduced by specific details.
The Availability Cascade: When Repetition Becomes Reality
Complementing this is the Availability Cascade, a phenomenon where an investment idea or concern gains traction and is amplified by media attention and social discussion, often irrespective of the initial evidence. Think of a widely repeated stock tip or a pervasive fear about a particular market sector. This bias highlights how an idea, fueled by its vividness and emotional resonance, becomes increasingly accepted as truth simply because it's widely discussed.
The mechanism is deceptively simple: an idea gains initial traction, perhaps through a single influential article or analyst report. Media outlets pick up the story, adding their own commentary. Social media amplifies the discussion further. Soon, the sheer volume of coverage creates an illusion of importance and validity. The original evidence becomes secondary to the social proof of widespread discussion.
In the investment context, this can create unwarranted bubbles of enthusiasm or deep-seated panics. The "China hard landing" narrative that dominated financial media for years created persistent bearish sentiment toward emerging markets, often regardless of actual economic data. Similarly, the "death of retail" thesis became so widely accepted that it created opportunities for contrarian investors who looked beyond the narrative to actual company fundamentals.
Legal scholar Cass Sunstein describes it as:
"...a self-reinforcing process of collective belief formation by which shared outrage or shared enthusiasm escalates progressively as people observe others expressing the same emotion."
This "shared enthusiasm" or "shared outrage" can significantly distort asset prices, pushing them away from their intrinsic value. The 2008 financial crisis saw availability cascades in both directions – first the euphoric belief in ever-rising house prices, then the panic-driven assumption that all financial institutions were doomed.
The Social Media Amplification Effect
Modern social media has turbocharged availability cascades. A single tweet from an influential investor can spark discussions across multiple platforms, creating the impression of widespread consensus. The "meme stock" phenomenon of 2021 demonstrated how quickly ideas can spread and gain perceived legitimacy through repetition and social validation, often with little regard for underlying business fundamentals.
The challenge for investors is distinguishing between ideas that are popular because they're correct and ideas that seem correct because they're popular. Just because an investment thesis is trending doesn't automatically equate to a sound investment decision.
What Can We Do: Practical Defences
Start with Base Rates: Before evaluating any specific investment, research the general success rates for that type of investment. What percentage of mining explorers successfully bring projects to production? How often do turnaround stories actually turn around? Let these statistics anchor your expectations.
Seek Contrarian Sources: Actively look for viewpoints that challenge popular narratives. If everyone is talking about an opportunity, specifically search for credible opposing views. This doesn't mean becoming a reflexive contrarian, but rather ensuring you've considered alternative perspectives.
Question the Source: When investment ideas gain momentum, trace them back to their origins. Is the underlying evidence solid, or has the story simply been repeated and embellished? Often, widespread investment themes rest on surprisingly thin original research.
Maintain Perspective: Remember that markets are forward-looking mechanisms. By the time an investment theme becomes widely discussed, much of the potential opportunity may already be priced in. The availability cascade that brings an idea to your attention might also be the reason it's no longer attractively valued.
Document Your Reasoning: Write down why you're making investment decisions, including what base rates you've considered and whether you're potentially influenced by popular narratives. This creates accountability and helps you learn from both successes and failures.
By consciously recognising these biases – our tendency to be swayed by compelling specifics over cold probabilities (Base Rate Neglect) and the allure of popular narratives (Availability Cascade) – we empower ourselves to make more informed decisions. As investors, especially those newer to the game, we must strive to look beyond the captivating stories and the loudest voices, grounding our choices in solid research, critical thinking, and a keen awareness of the underlying statistical realities.
The most successful investors aren't those who never encounter these biases – they're those who recognize them, plan for them, and build systems to counteract their influence. In a world of endless information and competing narratives, this awareness becomes a genuine competitive advantage.
Feedback
Week 11 (CHECK)! How are we all doing? Ready to put your brain in the bin? There's a worse one to come!
Please let me have any feedback below or just let me know if you're still enjoying them. I still have a couple more biases and tendencies to show and talk to you about and we'll do it all again next Saturday!