Investing is as much of an art is it is a science. Which is why our behaviour and our emotions can have a strong impact on our ability to make optimal investment decisions.
Understanding behavioural investing and how you can overcome your emotions to make important investment decisions can be integral to achieving your long-term goals. The Little Book of Behavioural Investing by James Montier explains the important behavioral challenges faced by investors. Listen to this Podcast by Edelweiss MF & learn more!
1. More often than not, investors are their own worst enemies. They let their emotions get in the way of making objective investment decisions.
2. According to some psychologists, our brain processes information in two ways, using two systems- the X system and the C system. The X system is more emotionally oriented and impulsive. It is the brain’s default mode of operation that comes into play automatically and effortlessly for generally quick responses.
3. The C system is not just more logical but is also slower than the X System. People who use the C System usually take time to take a step back, assess the situation, and then take a decision.
4. It because of the X System that we often let our behavioural and emotional biases overcome investment decision making.
5. The X System makes us over-confident and over-optimistic about our ability to make investment decisions and discourages us from thinking logically.
6. This gives rise to empathy gaps, ie., an inability to predict or control our future behaviour especially in an environment of emotional stress. When it comes to investing, empathy gaps can lead to massive losses. To avoid making mistakes due to empathy gaps, Montier advises the strategy of pre-commitment: to plan your investment when you are not agitated and the markets are stable.
7. Another behavioural bias that can be detrimental to optimal investment decision making is overconfidence. Various studies have found that on an average experts tend to be more overconfident and that humans tend to confuse confidence with skill.
8. Investors who are looking to overcome this bias should actively seek information that can prove their analysis wrong. This way they can ensure that the logic they are applying is free of bias.
9. Most people see inaction as a bad thing. However, investors must remember that the opposite of action bias is not inaction, but patience. Patience and discipline are the best friends of an investor.
The Little Book of Behavioural Investing by James Montier very clearly dwells upon behavioural investing and its value in investment decision making. We hope you enjoyed this Edelweiss Money Konnect podcast and will tune in to listen to more such podcasts on investing nuggets.