Keep this in mind….

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In my experience money shifts everything. When you engage someone in a way that involves money, tempers quickly become heated and rationality tends to evaporate. So, based on my experiences over the last week, I share three fundamental points.

Fraud

Ponzi in 1920There are four elements to any fraud:

  • False Representation: A false representation of a material nature (either misstatement or omission of a material fact)
  • Scienter: Knowledge that the representation is false, or reckless disregard for truth
  • Reliance: The person receiving the representation has reasonably and justifiably relied on it
  • Damages: The receiving party must sustain (financial) damage from all of the above

Without all four elements, alleging a fraud is an uphill battle, something that Sarit Tamar learned in 2010.  Sarit, an individual shareholder, had filed a purported class action securities lawsuit against Mind CTI, a company that I had invested in, certain of Mind CTI’s officers, and one of Mind CTI’s directors.

The complaint sought unspecified compensatory damages for, among other things, alleged misleading statements relating primarily to the company’s investment in auction rate securities.

The company defended itself against the suit, and in July 2010 the United States District Court for the Southern District of New York issued a decision, dismissing the complaint against all defendants without leave to amend.   In the order dismissing the lawsuit, the court noted that plaintiff had failed to establish a strong inference of scienter.

Knowing What Versus Knowing When

I have increasingly become aware of the difference between knowing something is going to happen and knowing when this something will happen.

The difference is material when you invest money the way that I do, i.e. with the knowledge that something is going to happen that will materially alter the value of my investment.

I am still struggling with coming to terms with this difference and regularly I think I have.    As I have discussed in another posting, for instance, my entire investment paradigm, which dictates an infinite time-horizon on investments, is supported by the fact that even if someone else know the same thing as I do, i.e. that something is going to happen, they may not be able to come to terms with the fact that this something may happen at an unknown future date, and, therefore, I have an edge.

Needless to say, having investors or partners is difficult under this paradigm, and, so, if you wish to follow the way of the indeterminate return-date, as I call it, you better be prepared to either walk it alone or have some very uncomfortable discussions during your journey.

Confirmation Bias, Cognitive Dissonance, and Motivated Reasoning

I recently wrote about cognitive dissonance, but failed to explain the term. It was, therefore, perhaps not surprising that when I in a conversation pointed out that someone was under the influence from confirmation bias was challenged to explain the difference between this bias and cognitive dissonance.

So here goes nothing… confirmation bias vs. cognitive dissonance, and for the sake of completeness, I include motivated reasoning, building a nice little triangle.

Not surprisingly, all three terms are about the most human or human character traits: Our clinging to our beliefs, even when confronted with overwhelming opposing evidence.

Confirmation bias is an easy start, providing an easy to use term for the peculiar tendency for humans to to look for what confirms their beliefs and ignore what contradicts their beliefs — regardless of objective truth. Interestingly, confirmation bias makes it perfectly possible for two individual of opposing views to each find support for his or her views in the same body of evidence.

Cognitive dissonance is just as interesting, but harder to use, since it describes a state of tension that occurs whenever a human holds two ideas that are psychologically inconsistent. As you may suspect, humans are not very good at holding such tensions, and, so, they automatically tries to resolve them by coming down hard on one side or another — whether or not it is objectively true — and frequently does so with passion in an attempt to mask the fact that the choice is dictated by belief and need for resolution, rather than truth.

Motivated reasoning is neat, describing humans’ tendency to accept what they want to believe with much more ease and much less analysis than what they don’t want to believe… we all know this one in its simple form whereby when our opponent wins a game against us, it is luck, but when we it is skill.

So there really are more similarities between confirmation bias, cognitive dissonance, and motivated reasoning than there are differences in that each tend to serve the same, simple purpose, namely to structure or frame the world in a way that makes sense to us. However, there are important differences, which it is worth keeping in mind: (1) motivated reasoning attempts to avoid cognitive dissonance, and (2) confirmation bias is complementary to motivated reasoning with confirmation bias being an automatic tendency to notice (only) data that fit with our beliefs and motivated reasoning being the tendency to scrutinize data more carefully if we don’t like the beliefs that they reflect.

What is interesting about this trinity is, of course, that humans don’t tend to change their mind. Rather, they tend to filter the world so it is not in conflict with their view, and, in fact, they are willing to engage in external conflict in order to not have internal conflict. So, it is like a triple defense for our world-views: We only look for what confirms our view, we only side with what is a good fit with our view, and we don’t scrutinize contrary ideas.

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