8 Psychology Lessons From “The Behavioral Investor”

The Behavioral Investor Summary

👇 The Behavioral Investor video summary 👇

The Behavioral Investor Lessons

1️⃣ Emotions rule the stock market (not money)

So, what really makes the stock market tick?

Some might say money, right? Well, it’s crucial, but here’s the twist – the people behind the money matter even more. Those folks decide when to buy, hold, or sell.

The tricky part? Our decisions often go haywire because our brains, despite being awesome, struggle in complex and stressful situations.

Here’s the deal: If you want to make wise money moves, you’ve got to accept that your brain won’t always guide you perfectly.

Our brains are wired to keep us safe, just like our ancient ancestors dodging saber-toothed tigers. Even though you’re not facing tigers at work, your brain acts like you are.

Now, when it comes to money risk, your brain’s alarm bells ring. It focuses on avoiding threats to keep you alive. The downside? It’s tougher to think clearly, and you might miss important stuff.

Also, our brains love quick rewards. Doing something that brings instant success gives us a dopamine hit, making us feel good. We crave that feeling, sometimes too much. As an investor, you might mess up your plans, chasing short-term wins instead of long-term success.

Sure, you might know it’s not smart to chase every quick buck, but our brains are hungry for money. Dr. Brian Knutson from Harvard says humans are drawn to money, no matter its real value. It’s tempting to go after rewards.

Here’s the catch: Your brain’s money cravings can cloud your judgment. But guess what? If you’re aware of it, you can be on top of things. Knowing your brain’s tricks helps you resist impulses and avoid doing things that could mess up your money game. Smart, huh?

Onwards.

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2️⃣ Humans are not as rational as you think

Ever noticed a connection between the stock market and the weather? It’s a bit quirky – globally, people tend to invest more during spring and summer. This behavior echoes our ancestors, who stashed food in warmer times to survive winter.

Here’s another nugget: markets often show low returns on cloudy days. Scientists think it’s because gloomy weather makes us less happy and more risk-averse.

These patterns shout one thing – our feelings heavily shape our actions. So, drop the act of being a super-rational adult; it’s time to admit the truth.

Key Message: You’re not as rational as you think.

When we decide, we’re pros at justifying our choices, convincing ourselves we’re doing the right thing. We also tend to trash-talk the options we didn’t pick, making us feel even better about our choice.

Challenge our decisions, and we get defensive, ignoring new info that shows we goofed. This ego-driven need to protect our self-identity makes it tough to change course, even when a decision flops. That’s why people cling to sinking investments instead of cutting losses.

Comfort is our jam. We stick to the familiar, even if it’s boring or bad, because change is scary. Fear of loss keeps us holding onto what we have, even if there’s potential for more.

Take the German town example – they could’ve had a shiny new town, but nope, they chose the same old, impractical design.

To rock as an investor, you gotta get comfy with discomfort. Markets change, losses happen, and regrets lurk. But if you accept this, you can take rational steps forward, not letting emotions anchor you in the past or freeze you with fear.

Next.

3️⃣ Overconfidence kills

Picture a world without confidence – no cool scientific discoveries, no innovative businesses, none of the wonders we enjoy today. Confidence can be a powerhouse, but here’s the twist: too much of it can lead to destructive, ego-driven behavior.

Key Message: Overconfidence is a liability.

When investors score wins, they often credit their unique skills, ignoring the fact that the whole market is rising. This overconfidence might make them keep buying, even when prices are sky-high. That’s a no-no in the “buy low, sell high” rule every smart investor should follow.

On average, investors overestimate their yearly returns by 11.5%. Turns out, they’re not as skilled as they think. And when returns drop, they struggle to admit it – egos don’t like facing failure. To succeed, leave your ego at the door each day.

Overconfidence also tricks investors into skipping diversification. When a company’s doing well, it feels like a sure bet. But even if a stock seems rock-solid, don’t put all your eggs in one basket. Aim for around 20 stocks in your portfolio. Why? Because the market is uncertain, and luck plays a part.

Diversification isn’t just about spreading risk; it helps with market predictions. Pooled judgments, considering many opinions, beat individual guesses. Economist R.M. Hogarth says seeking a dozen estimates gives solid guidance.

But beware of confirmation bias – our tendency to seek opinions confirming our own. Get predictions from diverse sources using different methods. Your ego might prefer agreement, but tapping into the crowd’s wisdom ensures informed decisions.

Moving on.

4️⃣ Embrace uncertainty

Take the Mona Lisa, for instance – considered a masterpiece now, but it was a nobody until stolen in 1911. Two days missing, and no one noticed. The media frenzy around its theft made it famous. Turns out, it was the scandal, not just the art, that drew attention.

This story reveals our love for the familiar. Your brain likes shortcuts, and familiar stuff is easier to process. Sadly, this habit puts your investment at risk.

Key Message: To invest successfully, embrace the unfamiliar.

Still skeptical about our love for the familiar? Check your favorite stock tickers. Easy-to-say names like MOO grab attention, while the not-so-easy ones like NTT get the cold shoulder.

This preference for the familiar extends to investing in homegrown stocks. Ideally, your portfolio should match the market size of each country. In reality, not so much.

British investors, for example, load up on local stocks (80%) despite the UK having just 10% of the world market value. Missing out on global opportunities and risking disaster.

Why? Normalcy bias – we think we’ve seen it all and delay reacting to disasters. Accepting financial upheaval is key to being a smart investor. Combat uncertainty by building diverse portfolios to weather the natural ups and downs.

Onwards.

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5️⃣ Broaden your views

Travel back to colonial Massachusetts in the 1690s – a time of witch trials. Accused women faced a bizarre test: float in water, and you’re a witch; sink, and you’re innocent. Either way, you’d end up gone.

Why didn’t people see the absurdity? Our attention gets hooked on high-risk, low-probability situations, stirring our emotions. This focus makes us ignore relevant info.

Key Message: To invest successfully, broaden your views.

High-risk situations can blind us to simple solutions. Many investors, in their quest for a market edge, end up with overly complex strategies.

Surprisingly, it’s not a genius manager or a cutting-edge process that predicts a fund’s success – it’s the fees, as found by data analysis company Morningstar. But if you’re obsessed with success and scared of failure, you might overlook this straightforward evaluation tool.

Another slip-up is fixating on a stock’s short-term performance. This is common if your decisions rely on probability, which works better over longer periods.

Daily market checks seem random; monthly trends don’t offer much insight. It’s when you zoom out to annual performance that the big picture emerges. Sadly, many investors bail before stocks reveal their true value.

To be a behavioral investor, take the long view. First, scrub your portfolio of any stocks at risk. Diversify to dodge disasters. Trust time; it’ll help you ride out short-term bumps.

Next.

6️⃣ Manage your emotions

Think about emotions – how many can you name? René Descartes had six in mind, but today we’re looking at a whopping 150-plus, blending into complex feelings.

While making financial decisions daily, these emotions are right there, influencing your choices. Don’t underestimate their power – especially in investing, where emotions can be a big hurdle.

Key Message: To invest successfully, manage your emotions.

Your emotional landscape shapes how you perceive situations, and it influences what you do with your money. Nobel Prize-winning economist Richard Thaler found that how we label money buckets affects our decisions. For instance, we save labeled “rebates” but spend labeled “bonuses.”

Enter goals-based investing, also called personal benchmarking. Split your money into safety, income, and growth buckets, then invest according to your emotions.

While emotions can be part of your strategy, they’re not always investment-friendly. Strong emotions lead to bad decisions. Counter this by slowing down your thinking, a skill you can develop through meditation.

Mindfulness exercises help you become more aware, creating space to consider details and make informed decisions over time.

Meditation is so valuable for investors that companies like BlackRock and Goldman Sachs have programs for their staff. Regular meditation reduces brain activity controlling greed, preventing mistakes from chasing quick rewards.

Even if you see yourself as well-regulated, emotions are so universal that you often don’t notice them. Paying attention helps you know when to follow them and when to keep them in check.

Next.

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7️⃣ Follow a solid plan

Let’s talk about your brain – a real data-processing champ. It can handle over eleven million bits of data simultaneously, yet only around 50 of these become conscious thoughts. Most of your brain’s power? That’s dedicated to your subconscious mind.

Considering the limited processing power for conscious decisions, it’s no surprise many investors trust their gut instincts. But relying solely on intuition isn’t a reliable investment strategy.

Key Message: To be a successful investor, understand the influence of your intuition.

Conscious thought is great for simple decisions but falls short when things get complicated. The more options you weigh, the tougher the decision-making process becomes. It’s hard to figure out what matters most, and as you struggle, confidence in your decision wavers.

Humans nail decisions when outcomes are predictable, situations are stable, and there’s quality feedback. Unfortunately, these conditions don’t exist in capital markets. Accept that conscious thinking isn’t the ideal decision-making tool for investors.

Here’s the good news – model-based approaches, like extrapolation algorithms, compensate for your brain’s limits. Surprisingly, models perform as well as, and sometimes better than, humans 94 percent of the time. They shine in stressful moments when human judgment falters due to fear.

As an investor, you’re bombarded with financial news, opinions, and the ever-present greed. Without a robust model, stress can break you. But with a committed approach to a model, your investment decisions won’t be hostage to your emotions.

Onwards.

8️⃣ Bubbles are part of the market

Let’s dive into the world of market bubbles – a love affair turned sour during the dot-com boom.

In the tech frenzy, investors went wild, grabbing shares in any company with a techy name. Mannatech Inc., a laxative manufacturer, saw its share price surge by 368% in the first two days of its public offering.

Love for the idea that every tech company would make us rich blinded us to warning signs. Reality hit, the bubble burst, and we had to clean up the mess.

Key Message: To be a successful investor, manage your fear of market bubbles.

Bubbles are part of capital markets, but they’re not as common as we fear. From 1800 to 1940, there were just 23 bubbles in the UK and US markets.

Traumatizing experiences make them stick in public memory. Fear of bubbles can paralyze investors, making it crucial to master emotional management.

To navigate market ups and downs, create a rules-based system. Get more conservative when things get shaky, focus on patience, and act infrequently. Don’t let daily emotions drive reactive decisions.

A momentum-based model with a 200-day moving average is a common system. Hold assets when their price is above the average, sell when it drops below. A ten-month moving average model works similarly.

Long periods of inactivity may seem odd in the fast-paced stock market, but they give you time to shift odds in your favor. Stick to your system even when fear kicks in. It’s the key to managing emotions and avoiding poor decisions driven by instinct.

The Behavioral Investor Review

In the world of capital markets, volatility is primarily fueled by investor decisions rather than the nature of money itself.

Despite our confidence, our brains aren’t flawless decision-makers, and various factors, from weather conditions to the familiarity of a ticker name, can subtly influence our investment choices.

To make better decisions, it’s crucial to comprehend how your brain reacts to stress and consciously choose a more informed approach.

Manage stress using the R.A.I.N. model.

In moments of acute stress, adopt Michele McDonald’s R.A.I.N model to regain a calm state of mind.

Start by Recognizing the physical sensations, like an increased heart rate.

Accept what you’ve observed, even if it’s uncomfortable.

Investigate the narratives you’re telling yourself about the situation and identify alternative thoughts.

Finally, practice Non-identification, acknowledging that feeling stress doesn’t define you.

The Behavioral Investor Quotes

🔥 Daily Inspiration 🔥

The quality and quantity of the service you render, plus the attitude with which you render it, determine the amount of pay you get and the sort of job you hold.

The people who are promoted to the best positions in the company are those who make it a practice to go the extra mile, to do more than they are paid to do, and to do it willingly and cheerfully.

You take the first important step toward determining your own future when you make the conscious decision to approach every task with a positive outlook and to stick with the job until it is done.

If you find this attitude difficult at first, you’ll discover it eventually becomes part of you.

And after you begin to realize the benefits that accrue to you because you are known as someone who always gives a little extra, you wouldn’t consider doing things any other way.

— Napoleon Hill