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How Psychological Factors & Emotional Intelligence Impact Investment Decision-Making


10Aug 2007

I’m on vacation this week — and when I’m on vacation (after the first few days of brainless activity), I dive in to books I have had in my reading pile for a while.  One of the books I brought, Inside the Investor’s Brain: The Power of Mind over Money by Richard Peterson, (published just this year) is quite interesting.  And I’d like to share some of the thoughts from the book with you all.

First off, Dr. Peterson is an associate editor at the Journal of Behavioral Finance, is a psychiatrist, a former stock trader and did postgraduate research at Stanford University in neuroeconomics (i.e. studying the neurology associated with financial decison-making).  So he is no lightweight.

Secondly, the primary focus of the book is to summarize the research which has been conducted over several decades regarding the psychological processes that underlie and impact investment decision-making, and to tie these factors to the physiological components that accompany them neurologically.  That is, Dr. Peterson looks at various decision-making strategies, the biases that interfere with good judgment, the emotional aspects (e.g. fear, overconfidence) that are intertwined, and what is going on chemically within the brain with these.

Rather than summarize the main points here, I want to just give some semi-random snippets of quotes that I personally have found interesting (page numbers follow the quote in parentheses).

“In investment management, mathematical genius may perform well in the short term, but it is no substitute for emotional intelligence.”  (2)

“The pursuit of profit for its own sake can quickly go awry. . . Pursuing profit as one’s primary goal can be a sign of emotional ill health. . . when money becomes the goal, rather than a by-product of enjoyable work, then emotional stability is apt to suffer.” (290)

“‘Our probability assessments shift based on how others present information to us.'” [Michael Maubossin]  Emotionally, investors have stronger reactions if possible outcomes are more vivid or imaginable. . .Stocks with exciting stories cause people to forecast high stock returns.” (179, 181)

“Because the future is intrinsically uncertain and market dynamics change, the past is a poor guide to the future.” (187)  “‘The fundamental law of investing is the uncertainty of the future.’ [Peter Bernstein] (179)  “‘The future is never clear, . . . Uncertainty is the friend of the buyer of long-term values.'” [Warren Buffet] (180) “‘Markets are constantly in a state of uncertainty and flux and money is made by discounting the obvious and betting on the unexpected.'” [George Soros] (182)

“But, in general, it is a congruence of characteristics, not any one individual trait, that leads to true excellence.  To achieve greatness in investing, education is the first step. . . . The next step is a self-evaluation. Identify your strengths and weaknesses and inventory your resources.  What is your psychological Achilles’ heel, and how will you protect it? . . . Small positive changes in psychological well-being, mental training and physical health improve the probability of successful decision making.  A slightly increased probability of success, over years of decision making leads to better long-term outcomes.” (289-290)

“‘Self-discipline is the single most important success factor.  Without it, nothing else matters.’ [Howard Fleishman, PhD, performance psychologist]. . . one’s degree of self-discipline correlates with wealth level.  In general, pursuing immediate gratification erodes prosperity. . .Investing ‘rules’ are useless for people who don’t first have discipline.” (295-296)  “‘No one can do your push-ups for you. [Jim Rohn]'” (290) 

“‘[Profitability] comes when the investor realizes that investment success does not come from external control, but from internal control.'” [Van K. Tharp] (301)

Dr. Peterson has a number of chapters on the emotional components of decision-making (intuition, fear & anxiety, excitement and its relationship to greed, overconfidence, the love of risk, and the impact of stress on decision-making).  Additionally, he summarizes a number of perceptual biases that affect making good decisions. (I hope to share those later).

To close, I’ll share from the preface to the book: “to really excel in investing, you’ve got to learn the skills to manage yourself.” (xv)

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