Effectively the sources of optimism can be split into those related to nature and those related to nurture. So let’s start with nature.
Many of the biases we have today presumably had some evolutionary advantage .What possible role could optimism have played in our evolution as a species? Lionel Tiger argued in his book Optimism: The Biology of Hope (1979) that when early man left the forests and became hunters many of them suffered injury and death. Tiger suggests that humans tend to abandon tasks associated with negative consequences, so it was biologically adaptive for humans to develop a sense of optimism. After all, it must have needed a great deal of courage to take on a mastodon (a very large prehistoric elephant-like creature); frankly, not too many pessimists would even bother. Tiger also argues that when we are injured, our bodies release endorphins.
Endorphins generally have two properties; they have an analgesic property (to reduce pain) and they produce feelings of euphoria. Tiger suggests that it was biologically adaptive for our ancestors to experience positive emotions instead of negative emotions when they were injured because it would reinforce their tendency to hunt in the future.
Optimism may also endow us with some other benefits. Psychologists have found that optimists seem to cope far better (and survive much longer) when faced with dire news over illness or other problems than pessimists do. So optimism may well be a great life strategy. However, hope isn’t a good investment strategy
.Ben Graham was well aware of the dangers of over-optimism. He noted: “Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions. The purchasers view the current good earnings as equivalent to “earning power” and assume that prosperity is synonymous with safety.”
So much for nature. Nurture also helps to generate the generally rose-tinted view of life. Psychologists have often documented a “self-serving bias ” whereby people are prone to act in ways that are supportive of their own interests. But, as Warren Buffett warns, “Never ask a barber if you need a haircut.”
Auditors provide a good example of this bias. One hundred thirty-nine professional auditors were given five different auditing cases to examine. The cases concerned a variety of controversial aspects of accounting. For instance, one covered the recognition of intangibles, one covered revenue recognition, and one concerned capitalization versus expensing of expenditures. The auditors were told the cases were independent of each other. The auditors were randomly assigned to either work for the company or work for an outside investor who was considering investing in the company in question. The auditors who were told they were working for the company were 31 percent more likely to accept the various dubious accounting moves than those who were told they worked for the outside investor.
We see this kind of self-serving bias rear its head regularly when it comes to investing. For instance, stockbroker research generally conforms to three self -serving principles:
Rule 1: All news is good news (if the news is bad, it can always get better).
Rule 2: Everything is always cheap (even if you have to make up new valuation methodologies).
Rule 3: Assertion trumps evidence (never let the facts get in the way of a good story).
Remembering that these rules govern much of what passes for research in Stock market can help protect you from falling victim to this aspect of self-serving bias.
Investing Mantras 