Aspects of Investor Psychology (via Mispricing)

One of my favorite blogs to read is Mispricing, written by Tong Kok Hooi from Malaysia. Tong recently linked to an article titled Apects of Investor Psycholog. The article centers around biases present in decision making.

Article Introduction (Thanks to the Mispricing Blog)

Decision theorist Howard Raiffa [1968] introduces useful distinctions among three approaches to the analysis of decisions. Normative analysis is concerned with the rational solution to the decision problem. It defines the ideal that actual decisions should strive to approximate. Descriptive analysis is concerned with the manner in which real people actually make decisions. Prescriptive analysis is concerned with practical advice and help that people could use to make more rational decisions.

Summary of Article’s Recommendations:

1. Keep track of instances of your own overconfidence.

2. Because you are more likely to remember successes keep a list of past investments that were not successful.

3. Ask yourself if you have real reasons to know more than the market.

4. When presenting alternative courses of action use the broadest available frame.

5. Assess your loss aversion.

6. In the education process, be careful not to inadvertently reinforce the tendency
towards overreaction to chance events.

7. Encouraging clients to adopt and to follow a sensible risk policy is one of the
important tasks of financial advisors.

8. Teach the investor the importance of taking a long-term view.

9. Pay more attention to what investors have done in the past than what they say they’ll do in the future.

10. Encourage investors to confront their propensity for regret.

(Note: I have paraphrased some of the recommendations.)

Click Here for the Full Article

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27. August 2008 by Miguel Barbosa
Categories: Curated Readings, Finance & Investing | Leave a comment

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