The Behavioral Investor explores how subconscious thoughts and emotions affect financial investments.
Throughout this book, Daniel Crosby provides insights and guidance to help you overcome your natural inclinations in order to make better financial decisions.
You may be wondering if you should read the book. This book summary will tell you what important lessons you can learn from this book so you can decide if it is worth your time.
At the end of this book summary, I’ll also tell you the best way to get rich by reading and writing.
Without further ado, let’s get started.
The Behavioral Investor Book Summary
Lesson 1: Successful investors learn to embrace the unknown.
As for works of art, the Mona Lisa is often considered the gold standard. It may come as a surprise, then, that the painting was largely unknown until 1911, when it was stolen from the Louvre.
It disappeared from the museum, and for two days no one noticed. Thanks to newspaper coverage, however, the theft became a media sensation. When the painting was recovered two years later, many people were eager to see it again. The fame of the painting stemmed more from its scandalous history than from its artistic quality.
This story illustrates man’s tendency to prefer the known. Making complex decisions requires a lot of work from the brain, so it often falls back on what it already knows to save time. Unfortunately, this trait can be detrimental to the safety of your investment portfolio.
Consider the names of the most memorable stock market acronyms if you need further proof that people are naturally drawn to what they are familiar with. Investors often favour companies with easy-to-pronounce names, like MOO, and overlook those with more complicated names, like NTT.
For the same reason, people tend to invest too much in domestic stocks because they prefer what is safe and familiar. In theory, the stock allocation in your portfolio should reflect the relative size of domestic and international markets. In practise, however, this is almost never the case.
For example, although the market value of the UK is only 10% of the world market, many UK investors invest 80% of their portfolio in domestic equities. Because of their preference for domestic opportunities, investors miss out on global opportunities. It also leaves portfolios vulnerable to destruction in the event of a disaster.
Of course, no one wants to believe that something bad will happen to them. Instead, we tend to think we have seen it all because we are fixated on normalcy. For this reason, many people wait until it is too late to leave their homes during a natural disaster.
If you want to be a behavioural investor, you must be prepared to weather the inevitable waves of change in the market. You can protect yourself from the ups and downs of the market by building a diversified portfolio.
Lesson 2: To be successful as an investor, you need a broader perspective.
In the 1690s, fear of witches ran rampant in colonial Massachusetts. The process by which women were convicted of witchcraft was absurd. Women who swam after being thrown into deep water were considered witches and were often executed as a result. If she drowned, she’d be considered innocent. Therefore, the defendant was executed regardless of the outcome of the trial.
How is it that the frightened locals couldn’t see the humor in their witch trials? Well, as humans, we’re naturally predisposed to focus on situations that carry a high degree of danger but have a low probability of actually occurring, or in other words, situations that trigger intense emotions in us. As a result of this selective focus, we often miss important details.
Nevertheless, investing always involves a certain amount of risk, so one should keep an open mind and not ignore the obvious.
It’s easy to overlook obvious answers when your life is on the line. As a result, many traders and investors try to gain an advantage with overly complex strategies.
However, research firm Morningstar has found that a fund’s future success cannot be predicted by a brilliant manager or the use of cutting-edge methods. Costs associated with investing. However, if you’re driven solely by your ambition to succeed and your aversion to failure, you may overlook this basic evaluation method.
Another common mistake is to look at a stock’s performance only in the short term. It’s a common strategy to base investment decisions on the probability that’s most effective over long periods of time.
Therefore, the behavior of the market on any given day seems unpredictable. Even if you go back and examine monthly trends, you won’t see much to indicate that you made a good investment decision. Still, the big picture becomes clear when you look at year-over-year performance. Too many people rush to sell their stocks before they’ve had time to show their true value.
To be successful as a behavioral investor, you need a long-term perspective. The first thing you should do is go through your stock holdings and divest yourself of companies you suspect are involved in fraud or bankruptcy. The next step to avert disaster is to diversify your funds. Finally, trust the passage of time. If you suffer temporary setbacks, it’ll help you recover.
Lesson 3: The ability to control one’s emotions is an essential prerequisite for profitable investments.
How many emotions do you think a person can feel?
René Descartes, a seventeenth-century French natural philosopher, suggested that there are only six basic emotions that we experience. However, the current scientific consensus disagrees. Author Dr. Watt Smith lists more than 150 different human emotions in his book The Book of Human Emotions: An Encyclopedia of Emotions from Anger to Wanderlust. In addition, these emotions can interact with each other to produce nuanced secondary emotions, such as nostalgia, which combines longing, sadness, and happiness.
Every time you make a financial decision, there is a wide range of emotions at play. Do not discount how much weight they carry in determining your actions. For the simple reason that investing with your heart can be very risky.
Your ever-changing emotional world affects how you interpret a particular situation. Just as your feelings about your financial situation affect the way you spend your money, your feelings about your financial situation affect the way you spend your money.
Consider the findings of Nobel Prize-winning economist Richard Thaler, who found that the names given to different pots of money influence people’s spending behavior. For example, we will set aside “rebate” money and spend “bonus” money.
This investment is the basis for goal-oriented investing, also known as personal benchmarking. You can use it by dividing your savings into three categories: Safety, Income, and Growth, and then investing according to your gut.
You may use your emotions when investing, but they will not always help you. That’s because when we are feeling particularly emotional, we tend to make poor decisions. One strategy to deal with this is to meditate and learn to slow down your thoughts.
Training your mind to be more present through mindfulness allows you to notice more of your surroundings. This prevents you from falling back on familiar options and, over time, leads you to make better and more thoughtful decisions.
BlackRock and Goldman Sachs are just two of the financial institutions that have implemented meditation programs for their employees because of the proven benefits to the industry. Those who meditate regularly are less inclined to make costly trading mistakes in pursuit of quick profits, as this behavior is associated with increased activity in the brain regions responsible for greed.
Even if you think you are a balanced person, you should keep in mind that everyone experiences emotions, even if you do not think about them much. However, if you pay enough attention to your feelings, you will learn when to let them guide you and when to rein them in.
Lesson 4: If you want to be a successful investor, you must learn to trust your gut.
You’ve a supercomputer in your head. It can process eleven million bits of data simultaneously. But only about 50 of those bits become actual thoughts. This means that your subconscious mind uses the vast majority of your brain’s resources.
Considering how few of our brain’s resources are available for conscious thought, it’s not surprising that many investors rely on following their instincts. This is risky and should be avoided.
Decisions that can be made with conscious thought are made quickly and accurately. But it’s not so useful when you’ve to make a complicated decision.
The more options you consider, the harder it becomes to choose one. That’s because it’s difficult to figure out which aspects are most important. And as you struggle to weigh the pros and cons, you lose confidence in your ability to make a sound decision.
People can only make smart decisions when the outcomes are known, the situation is unchanging, and there’s ample high-quality feedback to guide them. Unfortunately, these qualities aren’t present in the financial markets. So as an investor, you’ve to accept that conscious thinking isn’t the best decision-making tool.
Fortunately, you can compensate for your brain’s shortcomings with model-based approaches, such as extrapolation algorithms. An astonishing 94% of the time, models are as good or better at making decisions than humans. For this reason, they’re extremely useful in crisis situations and other situations where human judgment is impaired by fear.
As an investor, you’ll be bombarded with financial news, endless opinion pieces, and the greed of others as well as yourself. You’ll crumble under the pressure if you don’t have a reliable framework to guide your decisions. Investment decisions shouldn’t be based on your feelings, but when you commit to a model, they aren’t.
The Behavioral Investor Book Review
The Behavioral Investor is a great book I’d like to recommend to anyone who is interested in financial investment. If you spend some time digesting the ideas, it might make a positive impact on your life.
Capital markets are extremely volatile, but that’s primarily due to the actions of investors, not the nature of money itself. Unfortunately, our brains aren’t as good at making decisions as we think.
Unconsciously, our investment decisions can be influenced by factors as diverse as the weather or the sound of a ticker name. That’s why it’s important to know how your brain deals with stress so you can proactively make better financial decisions.
About the Author
Daniel Crosby is a behavioral finance and psychology expert who has published articles in the Huffington Post, Risk Management Magazine, and Investment News.
Personal Benchmark: Integrating Behavioral Finance and Investment Management, a New York Times best-seller, is one of his other books.
Buy The Book: The Behavioral Investor
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