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 self-preservation, not maximizing the growth of our investment portfolio. So we tend to use shortcuts called heuristics when it comes to making investment decisions. 

Heuristics are mental shortcuts or "rules of thumb" that people use to simplify decision-making. They allow individuals to quickly evaluate situations and make choices without needing to process all available information. While the use of heuristics can be an efficient way to move through the day, they can also lead to biases and inaccurate judgments when it comes to investing.

Investors often fall prey to cognitive and emotional biases that can cloud judgment and lead to suboptimal decisions. Here are some of the most common ones:
   - Confirmation Bias – Seeking out information that supports existing beliefs while ignoring contradictory evidence.
   - Loss Aversion – Feeling the pain of losses more intensely than the joy of gains, leading to overly conservative decisions.
   - Overconfidence Bias – Overestimating one's ability to predict market movements or pick winning stocks.
   - Recency Bias – Giving too much weight to recent events while neglecting historical trends.
   - Herding Behavior – Following the crowd rather than making independent, rational decisions.
   - Anchoring Bias – Fixating on an initial piece of information (like a stock’s past price) and failing to adjust expectations.
   - Endowment Effect – Overvaluing assets simply because they are already owned.
   - Sunk Cost Fallacy – Holding onto losing investments because of the money already spent, rather than reassessing objectively.
   - Home Country Bias – Favoring domestic investments over international opportunities, even when diversification would be beneficial.

In addition to the biases listed above, 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 often engage in panic selling, just as the market is nearing 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.

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.

Another example of self-awareness is recognizing when we are susceptible to suggestion. This usually happens when someone we like and trust gives us a stock tip, and we assume that they have done the necessary research into the company. As a result, we take the recommendation at face value and act on it without doing our own due diligence. Always do your own research, no matter where the idea came from.

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 contemplating an investment decision.