Here's why we make lousy decisions and what we could do about it

March 15, 2019

Here's why we make lousy decisions and

what we could do about it

It's no secret that we all have biases. Some biases are innate and some are learned responses to negative inputs. Some are quite clearly harmful and some aren't. Human judgement can't help but use biases kind of like a filtration system when taking in information. In other words, we see things through different lenses; a prism of sorts. No two people's biases are exactly alike. Like the old expression goes, "we see things differently". Another way to say it is "everyone has different judgement, some better and some worse". Biases are always at work, but some people have greater self-awareness over their biases than others. That's the point of this post.

This brings me to behavioral finance, which is a relatively new field that combines behavioral and cognitive psychological theory with conventional economic theory in order to propose explanations about why people make irrational decisions. By irrational, I mean dumb. Investopedia has a great course on the subject. I highly recommend it to anyone who wants to improve their decision making abilities. It's fairly brief too: Behavioral Finance

There are a few biases that are common among investors. How do we overcome these? By becoming self-aware of what they are. Because once you realize you have them and how they impact your investing decisions, you'll have the ability to negate them. It's not easy and it takes constant reminders.

From a list of "20 cognitive biases that screw up your decisions" via Business Insider, I could think of real world examples of how these biases played out to the detriment of investors' wealth.

The 3 ^rd one on the list is "Bandwagon effect". It's a powerful form of group think; when one's belief in something becomes stronger based on the number of people who share that belief. We saw this in the crypto mania late 2017, which imploded soon after.

The 7 ^th one, the one I think is most dangerous to investors and everyone else on the planet is "Confirmation bias", when people pay attention only to information that confirms their preconceptions.

The 12 ^th one is "Overconfidence". Some people are too confident in their abilities and as a result, take on risk greater than their risk tolerance. Experts are more prone to this because the see themselves as, well, as experts.

The 15 ^th one is "Recency", when investors extrapolate current stock market performance into the future. It's like thinking that the good times will roll on forever.

Here's the list with all 20. Take a good look at each one and think to yourself about how your understanding of them would make you a better decision maker. You don't have to study this list like a test will be handed out; just a basic understanding will help you a lot. Think of a real world experience in your life that each bias played a part in a decision you've made in the past and how the outcome would've been different if you were aware of the bias in question.

It's a great exercise and it doesn't take long.

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On another note, I'm getting my video reps in on YouTube, something I've been looking forward to doing for a long time. Please head over there now and check out a few videos. They're all about 2 minutes in length. And while you're there, please thumbs-up the videos you like and subscribe to my channel. Thanks!

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Mitch

I opened ClientFirst Strategy, Inc. because I believe that the only way to help my clients potentially achieve their goals is by offering unbiased advice & investment management expertise. To my clients, thank you for your continued vote of confidence. If you are not a client but would like to explore the possibility of becoming one, I invite you to call me directly, visit my website, join my email list, and/or connect with me on social media.

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