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Offbeat: The Road Less Travelled

Twist in the tale is that over 80 pc millionaires belong to the contrarian community

The population of the world is divided along many dimensions. There are physical dimensions, like fat people/thin people, brown/white people etc. Then there are psychographics, ie some like it hot and some like it cold etc. Among the many other dimensions, one of the most important is the "behavioural dimension", ie, the predilection to behave in a certain repeatable/predictable fashion. The economic aspects of this kind of behaviour are of great interest to marketmen.

Until now, Classical Finance studied human beings as static and uni-dimensional objects, whose aggregated behaviour was reducible to mathematical formulae. If that was not so, it was not worth studying, said the professors.

Practitioners, however, found their way round the professors. A new pseudo-science emerged, which found believers among practitioners, although it has still to gain wide acceptance among academics. "Believe if you want to, don't if you don't want to, but it works," said some of the best traders in the world. But this research cannot be called so, because it does not meet the rigorous standards of science, said the academics.

Stanley Danko puts out a surmise that went somewhat like this: the world is divided into people with two distinct categories of mind-sets, the 'majority' mind-set and the 'contrarian' mind-set. The majority set is clearly the dominant figure, with 97 per cent belonging to this club (he quoted a more exact number, but I don't want to get mathematical). Only 3 per cent are the contrarians.

The twist in the hitherto predictable tale is more than 80 per cent of the millionaires came from the latter (contrarian) community. Danko, came up with some other surprising findings, which were severely attacked for their lack of 'rigour'. But they made intuitive sense, and can be verified anecdotally by observing people around you.

The "millionaire mindset" is happy to be dowdy and unfashionable. Most American millionaires don't live in fashionable areas. They live wherever they started out from. A spectacular example is Warren Buffet, who still lives and eats at the same place he started out from, way back in the fifties.

They choose convenience and functionality in everything they do, not 'status'. It is the millionaire wannabes that buy all the aspirational products that denote millionaire-hood, not the millionaires themselves.

They don't change cars for the sake of change, they often buy second-hand, low-depreciation cars, they mostly stay married to the same woman and their children are often brought up with the same "middle-class" values that got them there.

So where does all the garishness of American consumerism come from? From the high-income earners not the millionaires. Income does not create wealth, the (millionaire) mindset does. The majority mindset pursues high-income, thinking that income creates wealth. The contrarian pursues a simple, unfashionable lifestyle, creating wealth by saving and investing whatever little income he gets. Understanding this subtle difference would be very good for all of us.

Contrarians distinguish themselves with a keen sense of balance. To use a driving paradigm, it is often said all good drivers may not be good investors, but all good investors are good drivers.

That is because good investors are able to balance out two very important 'linearities' evident in the majority of the population. One, they are able to understand the need to have an objective different from the crowd. For example, most ordinary people get into a car to go fast, so they then go fast...the logical linearity.

Good investors know that you enter markets to get a high return, but after you enter the markets, you should focus on managing risk/downside....the return will take care of itself. Similarly, you get into a car to drive fast, but after you are in the car, you focus on maximising safety. In this manner, good investors avoid the linearity that is a characteristic of most "majority mindsets".

The second linearity is called "self-attribution bias", i.e. the tendency to attribute all successes to yourself and to simultaneously externalise all failures to bad luck, the other car-drivers/market. The ability to behave in a manner that assumes and incorporates the (anticipated) mistakes of others is an ability unique to good investors.

In driving, the majority of drivers (about 85 per cent) believe they are good drivers something we know (at least in Delhi) is simply not true. This is simply over-confidence, seen very commonly in bull markets. In fact, in mature bull markets of the kind we see right now, this behavioural characteristic is very common...that all investment success is internalised (it was MY stock-picking that did it) rather than the more humble "I was lucky to make money".

The difficulty in classifying people on the basis of behavioural orientation (like contrarianism) is that human behaviour is neither constant under all conditions, nor scientifically measurable.

A fat man is fat under all earthly conditions, and measurably so. So patterns can be attributed to "fatness", which can be scientifically validated. But 'research' into contrarianism must stay anecdotal, and only those who find these patterns intuitively acceptable, will be influenced.

However, there is an emerging well-spring of information on this unique pattern of behaviour that is now finding its way into serious academia. The first, most interested readers are traders in financial markets, who are the first to admit to "groupthink" and its damaging consequences.

Locating and rooting out "groupthink" is not yet a priority in corporate boardrooms, probably because the damage because of it (groupthink) cannot yet be traced back. In another example of "self-attribution" bias, most corporates are able to externalise their misfortune to chance, the previous management or the Government. There is little introspection to locate the problem within, which is a known characteristic of crowd behaviour.

Crowds, especially large crowds, are monolithic, unthinking, linear and incapable of introspection. They are intolerant of contrarians, and reject any thoughts that fly in the face of "common wisdom". Contrarians have learnt, under pain of death, to live a dual existence...a public "yes man" who keeps checking back on his contrarians thoughts to see if has missed out on something.

Here is a little exercise that you can do, to assure yourself that these (two mindsets) exist. Next time, you are in a long linear car park, check the ratio of cars parked with their noses in (towards the kerb) and the cars parked with their noses out (towards the road). Take many readings of this ratio, and calculate the average.

I think two psychological patterns drive this number. One is the tendency to postpone pain (pain aversion), by which humans generally choose the option that postpones any pain. That is why we postpone a visit to the dentist, and in stocks, why we sell our winners and keep our losers. It is easier to park your car with the nose facing inwards, even though it increases the inconvenience and risk of taking your car out backwards.

Two is the tendency to herd.

As more and more cars are parked with their nose facing inwards, the new cars coming in will tend to do the same.

The paradigm built by the 'system' creates "culture", which promotes linearity, even if it is irrational. So it becomes a sort of 'rule' to park with your nose facing inwards. I know that this is so, because (in my housing society) I have often parked all my three cars together with their nose facing outwards, and then checked to see what the others do. I find that the cars around my cars are often parked with their nose facing outwards, but generally, the others are parked with their nose facing inwards. Over the last eight years, I have taken hundreds of readings of this ratio across maybe 10 cities in eight countries, but always found the ratio to vary around three out of every 100 (there are of course, outliers at times). I wonder if this can be called research.

The existence of linearity in the Majority Mindset takes on differing hues, ie, it varies. Beyond a point, it gives rise to a 'double-feedback', which is the source of such great volatility in markets. It happens rarely, but is remembered because it creates tsunami-like destruction of wealth among the populace. Maybe we have one building up just now.