Marcellus: Our Habits, as Much as Our Brains, Drive Investment Decisions

OVERVIEW

Published on: 26 April, 2019

Even though habits account for 40% of the decisions that we make, the “thinking” part of the brain does NOT control our habits. Understanding the auto-reflex element of habit-driven decision making is central to nailing down why some promoters consistently allocate capital better than others.

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“Habits are the invisible architecture of our lives…Habit allows us to go from ‘before’ to ‘after’, to make life easier and better. Habit is notorious – and rightly so – for its ability to direct our actions, even against our will…” ― Gretchen Rubin in ‘Better than Before: Mastering the Habits of our Everyday Lives’ (2015)

Habits drive 40% of our decision making
Over the past 20 years psychologists have not only discovered that our habits are far more influential than we understood them to be but also that our habits are NOT controlled by the “thinking” part of our brain. To quote bestselling author Charles Duhigg:

“Most of the choices we make each day may feel like the products of well-considered decision making but they’re not. They are habits. And though each habit means relatively little on its own, over time the meals we order, what we say to our kids each night…have enormous impacts on our health…and happiness. One paper published by a Duke University researcher in 2006 found that more than 40% of the actions people performed each day weren’t actual decisions, but habits….

When you dream up a new invention…it’s the outside parts of your brain at work. That’s where the most complex thinking occurs. Deeper inside the brain and closer to…where the brain meets the spinal column, are older, more primitive structures. They control our automatic behaviours, such as breathing and swallowing…Towards the centre of the skull is a golf ball-sized lump of tissue that is similar to what you might find inside the head of a fish, reptile or mammal. This is the basil ganglia…[Scientists have found that] basil ganglia was central to recalling patters and acting on them. The basal ganglia, in other words, stored habits even while the rest of the brain went to sleep.” – Charles Duhigg in ‘The Power of Habit: Why we do what we do in life & business’ (2014) [square brackets are ours]

Advances in science have now helped us understand how habits (or the “Habit Loop”) work in a three step framework. Sequentially, these are

1. A cue: this is a trigger (something you see, smell or hear) that transfers the brain into an automatic mode which determines which habit to use;

2. A routine: this is the heart of the habit and is typically a mental, emotional or physical routine; an

3. A reward: this helps the brain ascertain if this specific loop is worth remembering for the future.

Duhigg says that, “The cue and reward become neurologically intertwined until a sense of craving emerges”. For example, when I wake up on weekdays, I keep my running shoes kept close to the bed. That is my cue that I need to get some exercise. That cue triggers a routine of putting on my gym clothes, going down to the gym and working out. Throughout this process, I need a reward which keeps me going through the dark Mumbai mornings (accompanied by heavy rain from June-September). My reward is a peanut butter sandwich with jam layered on top for breakfast. My wife ensures that I won’t get the sandwich if I don’t go to the gym. That’s how my exercise habit loop works.

The nature of our habits influences our investment returns
Clearly, our habits will influence financial decisions. Whilst this phenomena is multi-layered, it is possible to understand the understand the simplest layer in 200 words.

When we meet companies, the meeting often place in the promoter’s office itself (rather than in a meeting room). Most such offices have a TV and hence the promoter is exposed to cues emanating from the TV. Associated with these cues, are likely to be routines/habits for the promoter eg. he might be accustomed to calling up his broker after seeing the share price of a stock he holds surge or he might have got into the habit of calling his CEO when he hears newsflow about a competitor. At the end of these routine(s), there is a “reward” that the promoter has got accustomed to receiving eg. his broker giving him good news regarding his stock portfolio (reward = “wealth trip”) or his CEO giving him good news regarding how the competition is being pulverised (reward = “power trip”). Such routines – either cued by TV, email or social media – form a large part of the working lives of many decision makers we meet. Much of the remainder of their time is taken up by meetings (which itself becomes another habit). As a result, very little of the corporate lives of many senior decision makers is actually used for thinking & contemplation.

A small minority of promoters have no TVs in their offices; many of these promoters also don’t seem to make active use of mobile phones. Such people arguably have more time to think & read i.e. more time NOT spent spinning on a habit loop. Such promoters are often to able see their industry from unusual angles. Unsurprisingly, there is a strong correlation between such promoters and our Consistent Compounders Portfolio. To quote from ‘The Unusual Billionaires’ (2016): “’Most Indian companies tend to focus on short-term results and hence that makes them frequently do things that deviate away from their articulated strategy…these deviations take them away from the path they have to travel to achieve their long term goals…the willingness to resist the temptation of short-term ‘off strategy’ profits for long-term sustainable gain is not there in most leading companies,’ writes Rama Bijapurkar, a leading market strategy consultant…
The typical promoter profiled in [“The Unusual Billionaires’] is patient and persevering, even bordering of the boring. He ignores short-term thrills based on flavour-of-the-month ideas. He consciously rejects aggressive forays into unrelated businesses…Such behaviour requires tremendous patience and a willingness to ignore the stock market’s proclamations regarding prevailing fads and fashions.”

Berger Paints, Marico and HDFC Bank are amongst the companies covered in detail in “The Unusual Billionaires.” It is, I think, safe to say that the habits of the people running these firms have contributed substantially to the success of the three firms.

If you want to read our other published material, please visit https://marcellus.in/blog/

Saurabh Mukherjea is the author of “The Unusual Billionaires” and “Coffee Can Investing: the Low Risk Route to Stupendous Wealth”.

Note: the above material is neither investment research, nor investment advice. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services and as an Investment Advisor.