Lessons in Behavioral Investing
How Our Emotions and Biases Impact Our Financial Decisions
When it comes to financial decision-making, we are oftentimes our own worst enemies. Human nature makes us susceptible to emotional responses, lack of willpower, overconfidence, and personal biases that impact our money mindsets and our financial decisions. Any one of these things can lead us to make less-than-wise decisions with our money, and this is certainly true when it comes to our investments.
As in many areas of life, we all make smarter decisions when we become aware of our inherent weaknesses and put measures in place to overcome them. Understanding more about the psychology around investing is one way to protect yourself from yourself.
In his bestselling book, The Little Book of Behavioral Investing, author and expert James Montier discusses some of the most important behavioral challenges facing investors. He also shares time-tested advice on how to avoid investment pitfalls and achieve your wealth-building goals. Below, we’ll review several of his key concepts.
We are Easily Susceptible to Confirmation Bias
As human beings, we all tend to hang onto our own viewpoints long after evidence or experience point us in new directions, simply because we spent time and effort developing our beliefs and we feel anchored to them. When we see data that confirms our beliefs or hear an opinion from someone else who agrees with us, our confirmation bias means we have a tendency to favor those data sets and opinions – even if there are overwhelming amounts of information and opinions to the contrary.
Willpower isn’t Enough to Overcome Behavioral Biases
We’d all like to believe we’re capable of pushing through our inherent biases to make better decisions, but Montier’s research shows otherwise. Willpower, while useful in many contexts, simply doesn’t create lasting change. Rather, we must rely on systems and formulas to remove the danger of biases for us.
Don’t Mistake Confidence for Intelligence
Experts of all kinds, including investment experts, tend to be more confident than the majority of us. It’s easy to get caught up in the herd mentality of simply investing as the experts recommend, but we must be careful not to abandon our own values in the process.
We Judge Decisions Based on their Outcomes
Instead, we should be judging based on the quality of the decision-making process. Outcome bias is a tough one to overcome in investing because of our natural inclination to value decision-making that leads to a positive result and to devalue the decision-making processes that ended in poor outcomes. We should all be more process-focused in order to guard against outcome bias. This means being disciplined in sticking to the processes we’ve built on our values and trusting in them to lead us to investment success.
We Expect Investing to be Exciting
Wall Street is constantly trying to sell us something sexy and exciting. In truth, though, if we are investing the right way then it should be a fairly boring endeavor. We need to remind ourselves to ignore the shiny new strategies and stick to what we know has given us steady, consistent success – even if it’s not as exciting as we thought it might be.
The above concepts of behavioral investing are useful in opening our eyes to the natural pitfalls we face as investors. Using what we learn, we can then work to eliminate the impact of our emotions, personal biases, and more, and focus on the mindsets, processes, and strategies that optimize our chances at success.
For more on behavioral investing concepts, check out James Montier’s The Little Book of Behavioral Investing.