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The internet is brimming with resources that proclaim, “Nearly Everything You Believed About Investing is Incorrect.” However, there are far fewer that aim to help you become a better investor by revealing that “Much of what you think you know about yourself is inacurate.” In this series of posts on the psychology of investment, I will take you through the Journey of the biggest psychological flaws we suffer from that causes us to make dumb mistakes in. This series is part of a joint investor education initiative Between Safal Niveshak and DSP Mutual Fund.
The world is an uncertain place. A Country’s Economy Grows at 7% and Yet the Stock Market Crashes. A Company You’ve Never Heard of Suddenly Backets A 50-BAGGER, and Another You Followed Religious DISAPPEARS INTO BANKRUPTCY. Interest Rates Rise, but the Markets Rally. Crude Oil Falls, and Inflation doesn’t budge. Predictions Fail, but still new ons are made with remarkable confidence.
Despite this randomness, and maybe trust of this, we are constantly in search for order. We Tell Oyselves, “There must be a reason.” And when we can’t find one, we make one up.
So, we make up “stories” or narrants that connect the dots, even when the dots were never meant to be connected. And we do this trust
Now, nowhere is this tendency more evidence, and more dangerous, than in the way we invest.
Every Investor, No Matter how rational they believe themselves to be, have at some point Fallen in love with a story. A Clean, Confident Narravet that Connects All the Dots, Things Like Past Success, Present Growth, and Future Dominance.
- “The founder has vision.”
- “The product has potential.”
- “The sector is booming.”
- “The world is changing, and this company is riding that wave.”
- “This time is different.”
But step back for a moment. Is this investment? Or is it wishful storytelling dressed up in well-made charts?
The term for this tendency is Narrave Fallacy, Which is acognitive bias that causes us to overvalue explanations that are co are co fac, emotionally appealing, and easy to remmber, whilera to undervaluing the contrastory of reality.
In his book, Black swanWhere he describes narrative fallacy in detail nassim taleb writes –
It is actually a fraud, but, to be more polite, I will call it a fallacy.
The Fallacy is associated with our vulnerability to overinterpretation and our predilection to compact stories over raw truths. It severely distrits our menal representation of the world; It is particularly acute when it comes to the rare event.
So, we Iron out the rough edges of whatsatically Happy Clean Cause-Rand-Effect Stories that Feel Right, even if they are available entrely true. All we need to prove this bias exists is to look at any investment we’ve made and try to explain, after the fact, why it is up or down.
Switch on any Financial News Channel Around Market Close, And Within Seconds, Someone Well-Dressed Will Confidently explain Why The market moved the way it did. “Markets Ended Higher Today after Strong Earnings from Tech Giats.” Or, “Markets Slipped on Fears of Rising Interest Rates.” IT Sounds Precise. Neatly packaged. As if the day’s price action had a single, clear cause. Rarely is it that simple. But our minds crave simplicity, and stories give it to us.
Daniel kahneman Wrote in Thinking, fast and slow:
Flawed stories of the past shape our views of the world and our expectations for the future. Narrave Fallacies Arise Inevitally from our Continuous Attempt to make sense of the world. The explanator stories that people find compeling are simple; Are concrete rather than abstract; Assign a larger role to talent, stupidity, and intenses than to luck; And focus on a more striking events that happy rather than on the countless events that failed to happy. Any recent salient event is a candidate to become the kernel of a causal narrative.
Kahneman, who coined many of the mental models we go now to undersrstand bias, explains that humans are not built to deal well with randomness. We Crave Order and Patterns. And when there patterns do’t exist, we create them. That’s what stories do. They offer the illusion of understanding.
Investing, that illusion can be costly. What begins as a basic idea, say, a company operating in a fast-road sector (EVS, Solar, etc.), Can Quickly Morph into a Grand Vision.
We start to assign narratives like “Disruption” and “Transformation.” These words carry emotional weight. They also Carry Risk, Because they Demand Less Scrutiny. A powerful narrative has the unique ability to make us stop questions. We want the story to be true, so we bend the facts until they fit.
Behavioral Research supports this tendency. Studies in cognitive psychology have shown that people are more likely to believe and remember information when it’s embedded in a story rather than in abstract data.
Neuroscience Reveals that Storylling Activates more regions of the brain than Factual presentation alone. It literal feels better to process a story than raw numbers.
Robert shiller, the nobel-winning economist, referrs to this as “narrable economics”, which he defined as the idea that stories themselves from markets, not just just fundamentals. In other words, we don’t just respond to data, but to the way the data is Told.
Now, there’s also an emotional component that complicates things. When we beyeve in a story, we feel a sense of control and Clarity. We imagine future headlines. We Picture Oatselves as Early Believers in Something Big. That anticipation of being right and spotting the next big winner produces a dopamine hit. It’s intoxicating. But this emotional engine also clouds judge. It becomes harder to see risks, to accept that the story might not play out, and to sell when the facts change.
And so we end up justifying and rationalising.
We find other believers and form echo chambers. We say things like, “It’s a long-term play,” or “Markets just don’t Get it yet.”
We use Valuation as a flexible tool. So, if the stock price falls, it’s “a buying options.” If IT Rices, “We We We Right All Along.”
At no point do we question the integrity of the original narrative, beCause by then, we’ve tied it to our identity. It’s now not just a story about a company but a story about us being smart and wise.
But reality does not care about coharence. It doesn’t move in straight lines. And a lot of stories have a sad ending. Businesses Falter. Competition Arrives. Demand shifts. Promoters Change Direction. And the narrative that Once Felt So Clear Suddenly Doesn’t Doesn What’s What’s Going on.
And now we’re statual trust we Didnys’st prepare for the possible that the story was never the full trousing. We are now like that Emperor with no clothes.
Now, this doesn’t meaning all stories are bad. Stories Help Us Remember Key Lessons (Like Buffett Using an aesop fable to explain dcf). Stories help us teach. Even the best investors use narrative to frame their thinking. But the Crucial Difference is that they start with Substance and Let the Story Emerge from Facts, Not the Other Way Around.
In contrast, the narrative Fallacy begins with belief and retrofits the facts. That’s the Danger.
How to Protect Against Narrative Fallacy?
We are humans, and the mind is what it is. But the reason we want to learn about the holes (biases) in our minds is that we can then learn to minimise the mistakes that get other people (who doo doo don’t undersstand such biasses).
And so, it’s important to look for ways to protect orselves against, well, orselves. That also holds true for the need to protect orselves against the narrative Fallacy.
One of the ways to do that is by BECCEMING Aware of how often we’re drawn to simplicity. When something feels too neat, too exciting, or too certain, that’s usually a red flag. Businesses are complex, but if the management’s narrative sounds like a ted talk, pause and look against.
Second, Learn to separate the story from the numbers. Look at cash flows. Look at capital allocation. Look at what the company actually does, and not just what it says it will do. Ask yourself: would i be interested in this business if I have no management narrative but just the finance?
Third, Pay Close Attention to How the Story is Spreading. Is it being given by objective and experienced analysts and investors or by social media influencers with a stake in the game? Is the story consistent over time, or constantly shifting to fit new developments? Remember that when stories evolve faster than earnings, something is off.
Fourth, Invert the story. Play devil’s advocate. Ask: if this turns out to be a poor investment, why might that happen? Also Ask: What are the Blind Spots I’M Ignoring? This Kind of Reflective Thinking Should Help You Ground The Story in Reality.
And finally, Ask yourself this uncomfortable but important question: am i holding this stock because of what the business is Doing, or trust of what I want the story to why? That distinction is often the line between rational investment and emotional attachment.
In the end, the stock market is not a book of well-told stories or Fairy Tales, but a place where capital meets uncertainty. And while stories will always be part of how we process the world, we must be the urge to treat them as fact.
Investing requires bot imagination and discipline. It’s okay to admire the narrative. But we must invest in the business, not what the stories Tell it is.
This is a person with the music stops and reality shows up, we want be left holding a great story. We’ll be left holding the consorteles of having mistake
Reflect: What’s one story you’re beLieving right now… About a company or your portfolio… that you haven’t questioned in a white?
Also read:
The sketchbook of wisdom: a hand-crafted manual on the pursuit of wealth and good life.
This is a masterpiece.
, Morgan Housel, Author, The Psychology of Money
Disclaimer: This article is published as part of a Joint Investor Education Initiative Between Safal Niveshak and DSP Mutual Fund. All mutual fund investors have to go through a one-time kyc (Know your customer) process. Investors Should Deal only with Register Mutual Funds (‘RMF’). For more info on KYC, RMF & Procedure to Lodge/ Redress Any Complaints, Visit dspim.com/ieidMutual Fund Investments are Subject to Market Risks, Read All Scheme Related Documents