Self-Awareness

In this lesson, you will learn how behavioral economists describe various aspects of investor behavior. Very few of us are "natural born" investors. Our brains are hard-wired for survival and reproduction, not maximizing the growth of our investment portfolio. So we tend to encounter internal conflicts of interest when it comes to making investment decisions.

For example, we have a very strong fight-or-flight response to perceived threats to our survival. When the stock market goes through one of it's bouts of volatility, many of us react as if our survival is being threatened. If the market is really rocky, we tend to panic at the worst time and sell our holdings near the bottom.

Therefore, the first question you need to consider is what is your tolerance for financial risk? Because you are experienced as an investor, you have the ability to look at your actual behavior during times of market turmoil. That's exactly what you should do. Don't rely on what you think you would do if the market suddenly dropped, because most investors believe they are much better than they actually are at remaining calm in the face of adversity. Go back and look. It may be an eye-opening experience.

Another question has to do with decision bias. Investing is making a series of buy and sell decisions over time. When you make a decision, are you aware of your natural biases and assumptions? We all have them. There's no escaping decision bias. A skilled investor may have the same biases and assumptions as an unskilled investor, but the difference is that the skilled investor knows she has them, and therefore is able to take them into account when she makes decisions. An unskilled investor who is not aware of (or wont admit to having) biases and assumptions will make the same misjudgments and errors repeatedly, because he is unaware of the biases that are at work.

Other examples of self awareness include susceptibility to suggestion, weakness in math or probability skills, a preference for certain companies, industries, or countries (home bias), and there are many others. Think of it this way. A perfectly rational and unbiased investor would have complete command of his emotions and intellect, and would use them with full efficiency. This investor would be very close to Star Trek's Mr. Spock. But he doesn't exist in the real world. So in order to improve as an investor, all you need to do is find your weaknesses and learn to make allowances for the fact that you have them when you are considering an investment decision.