“Whenever someone else performs poorly or makes a mistake, it’s a direct result of their actions.  Whenever I make a mistake, it’s because of a circumstance I had no control over!”

This is the underlying position of the fundamental attribution error.  We have a tendency to over emphasize the result of other people’s actions as personality-based.  A person’s actions are not situation-based but rather determined by what kind of person they are (or other unrelated factors).  However, when justifying their own behavior, people are more likely to attribute situational events (also known as actor-observer bias).   Author Malcolm Gladwell takes a slightly different approach to this and gives an example.  He writes about a study that shows how neat a students homework is or how punctual they are to class tells us absolutely nothing about how clean his room is.  However, we attribute something unrelated to his personality, and make other judgements on it. 

In investing, there are many times we can fall into this trap.  Let’s say we know certain factors about a company (Apple [AAPL]):  1.  The CEO and CFO are making a lot of money from the company 2. Their products are very well made and selling well.  From these known factors, we assume that AAPL is a strong stock to buy and dump a lot of money into it.  We falsely attribute unrelated factors (the “personality” of the company) to stock prices and make a decision based on it rather than looking at “situational” factors (financial statements, valuation etc).  We can avoid falling into this trap by looking at a broad picture of a company and focusing on those factors that directly correlate to its stock price.  Do you have any good examples of fundamental attribution error in your lives?

Tomorrow…  anchoring!