The Psychology of Investing #3: When Control is Just An Illusion

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

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 inaccurate.” In this series of posts on the psychology of investing, I will take you through the journey of the biggest psychological flaws we suffer from that causes us to make dumb mistakes in investing. This series is part of a joint investor education initiative between Safal Niveshak and DSP Mutual Fund.

The Art of Thinking Clearly is an excellent book by Rolf Dobelli. In one chapter, Dobelli shares a couple of instances –

Every day, shortly before nine o’clock, a man with a red hat stands in a square and begins to wave his cap around wildly. After five minutes he disappears. One day, a policeman comes up to him and asks: ‘What are you doing?’ ‘I’m keeping the giraffes away.’ ‘But there aren’t any giraffes here.’ ‘Well, I must be doing a good job, then.’

A friend with a broken leg was stuck in bed and asked me to pick up a lottery ticket for him. I went to the store, checked a few boxes, wrote his name on it and paid. As I handed him the copy of the ticket, he balked. ‘Why did you fill it out? I wanted to do that. I’m never going to win anything with your numbers!’ ‘Do you really think it affects the draw if you pick the numbers?’ I inquired. He looked at me blankly.

Let me share a personal example. As a child, I loved playing the game of Snakes and Ladders. This was despite rarely winning at it. It was a game of chance, but I somehow believed you needed skills to reach the finish line, leaving all the snakes and your opponent behind.

So, when my opponents pushed the dice toward me, I picked it up, feeling its weight in my hand. Then, I blew on it for luck, shook it vigorously, rotated my wrist, and let it fly. The dice tumbled across the table, and… I got a six, or a ladder, or missed a snake. Whenever I did not go through this ‘elaborate procedure’, I was bitten by a snake and found myself at the bottom of the table again.

Now, let me ask you a question: Does blowing on the dice or shaking it in a particular way influence the outcome?

I would have answered “yes” 35 years ago, but if you are my age now and answer yes, congratulations! You have just fallen victim to the “illusion of control,” a psychological bias that is as prevalent in Snakes and Ladders as in casinos, or cricket (watching from a particular seat or position so that your team wins!), or in the stock market.

If you answered no, do not get too confident because the illusion of control has influenced your investment decisions more than you realise.

When We Think We Are the Boss

Leonard Mlodinow wrote in The Drunkard’s Walk –

People like to exercise control over their environment, which is why many of the same people who drive a car after consuming half a bottle of scotch will freak out if the airplane they are on experiences minor turbulence. Our desire to control events is not without purpose, for a sense of personal control is integral to our self-concept and sense of self-esteem. In fact, one of the most beneficial things we can do for ourselves is to look for ways to exercise control over our lives – or at least to look for ways that help us feel that we do.

The illusion of control is our tendency to believe we can influence outcomes over which we have no sway.

It is the mental equivalent of repeatedly pressing an elevator’s “Door Close” button, thinking it will make the doors shut faster (spoiler alert: it often doesn’t).

Psychologist Ellen Langer first studied this phenomenon in her groundbreaking 1975 study published in the Journal of Personality and Social Psychology. She found that people were likelier to bet higher amounts on games of chance when they felt a sense of personal involvement. This was even when that involvement had no actual impact on the outcome.

Look at the world of investing, and you see the wide prevalence of this illusion that has often led investors down a dangerous path. Look at your investing experience, and you will understand what I mean.

We often think we can predict market movements, time our investments perfectly, or pick the next multi-bagger stock based on our ‘superior’ analysis. That’s rarely the case.

But why do we fall for this illusion? Once again, let’s shift the blame to our cave-dwelling ancestors and their survival-oriented brains.

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

Evolutionary Roots: When Control Meant Survival

For our ancestors, having a sense of control over their environment was necessary for their survival. Those who believed they could influence outcomes while hunting, predicting the weather, or avoiding predators were likelier to act and survive to pass on their genes.

This belief in personal control was adaptive in an environment where immediate action could mean the difference between life and death. What is more, our ancestral environment was relatively simple. Opportunities and threats were tangible and immediate.

However, in today’s world, such a need for control that comes from our mental wiring is causing us to overestimate our influence in complex, largely unpredictable systems like financial markets. The same mind that once helped us survive on the savannah can lead us astray in the modern investing world. Our brains have not evolved to deal with abstract concepts like compound interest or market volatility.

Understanding this evolutionary backdrop helps explain why the illusion of control is so pervasive and powerful in investing. It is not just a quirk of human psychology but a deep-seated, evolutionarily ingrained tendency that once served us well but can now lead us astray.

Illusion of Control in Investing: A Recipe for Disaster

Let’s talk more specifically about investing now. The illusion of control shows up in several ways here:

1. Over-trading: When you believe you can outsmart the market, you buy and sell excessively, which often results in higher transaction costs and lower returns. A study by Barber and Odean published in The Journal of Finance in 2000 found that people who traded more frequently earned annual returns 6.5% points lower than the overall market.

A recent study by SEBI in India also revealed that between the financial year FY22 and FY24, more than one crore Indians “tried their luck” with derivates trading, and about 93% of these traders made an average loss of Rs 2 lakh each, amplified by high costs, such as brokerage fees and taxes.

We won’t learn. Blame the ancestors!

2. Ignoring Index Funds: I have been a culprit here. I was not in favour of index funds till a few years back, as I believed, in the Indian context, they were not created well and were costly for the kind of efforts the money managers had to take to manage the same. After seeing the behaviour of investors with greater interest over the past few years (we remain our worst enemies and often cannot beat the average returns of the market because of that), and due to the overall development of the market for such a product, I now believe that index funds have a role to play in a non-professional investor’s portfolio.

Most of us think we can beat the market through active stock picking despite overwhelming evidence that even most professional fund managers fail to outperform index funds over the long term. It’s time to get over that illusion.

3. Misinterpreting Past Success: Here’s a thing I can reveal about you without knowing anything about you. When you make a profitable investment, you often attribute it to your skill rather than luck or broader market trends. If you think my interpretation is wrong, you can stop reading right away, for you are already enlightened. Else, read on.

This tendency, known as “self-attribution bias,” is a close cousin of the illusion of control. It is as common among investors as suits are on investment bankers. It is the cognitive equivalent of patting yourself on the back for a sunny day. You feel good, but you did not actually cause the weather. That is also how we often think about our investments.

When an investment goes up, we quickly take the credit – “I knew it! My research and insight paid off.” When an investment goes down, we quickly blame external factors – “The market is irrational,” or “If only that unexpected event hadn’t occurred.”

This selective attribution – taking credit for successes and blaming failures on external factors – can lead to a dangerously inflated sense of our investing abilities. But wait, blame the ancestors!

4. Overconfidence in Predictions: Under the trance of the illusion of control, we place too much faith in financial forecasts and market predictions, forgetting that the market is influenced by countless unpredictable factors.

This overconfidence in predictions is not just a problem for amateur investors. Even the experts you watch in media fall into this trap. Turn on any financial news channel, and you will see a parade of analysts confidently proclaiming where the market is headed next. These predictions often come with impressive-looking charts, compelling stories, and an air of absolute certainty. But the truth is that these forecasts are usually no better than guesswork dressed up in a suit and tie.

Charlie Munger once said it brilliantly –

The trouble with making all these pronouncements is people gradually begin to think they know something. It’s much better to think you’re ignorant … If people weren’t so often wrong, we wouldn’t be so rich.

The illusion that you can accurately predict market movements or those of the stocks you own is not just misguided but is downright dangerous to your financial health. In fact, predictions about the stock market – whether from an expert or your own analysis – are typically no more accurate than chance (like the game of Snakes and Ladders). The sooner you accept this reality, the sooner you can free yourself from the dangerous illusion of control.

As the great economist John Kenneth Galbraith once quipped –

The only function of economic forecasting is to make astrology look respectable.

The next time you are tempted to base an investment decision on the latest market prediction, pause and ask yourself: Am I making a reasoned decision, or am I simply succumbing to the illusion of control?

Let Go to Gain Control

To truly gain control over your investments, you must first accept how little control you have.

Accepting your lack of control does not mean you become a passive investor. It means you can now focus your energy on the things you can mostly influence, like –

Working on your investment process

Allocating your assets well

Controlling your investment costs

Managing your own behaviour as an investor

New learning to help you become better, and

Preparing to deal with both good and bad times in investing.

I must remind you here that the goal is not to eliminate the illusion of control entirely because that is impossible, given our evolutionary baggage. Instead, the goal is to recognise when this bias influences your decisions and develop strategies to deal with it.

Like I thought with my games of Snakes and Ladders, we are certainly not controlling the dice. But when we understand our limitations and focus on what we can control, we can tilt the odds a bit more in our favour. In investing, as in life, sometimes that is the best we can do.

So the next time you feel the urge to trade or invest based on the latest hot tip or market prediction, take a deep breath and remember: The illusion of control is just that – an illusion. True investing wisdom lies in knowing the difference between what we can change and what we cannot, and having the serenity to accept it.

Now, if you will excuse me, I have to prepare a good lunch for my wife, so she is happy with me after I could not take her shopping yesterday. It may be my illusion, but you never know. It might work this time!

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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 Registered Mutual Funds (‘RMF’). For more info on KYC, RMF & procedure to lodge/ redress any complaints, visit dspim.com/IEID. Mutual Fund investments are subject to market risks, read all scheme related documents