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Apprenticed Investor: Curb Your Enthusiasm

Decisions vs. Decision Making

One of the reasons that emotionally restricted investors have an advantage over everyone else is that they eliminate emotional decisions. It's a battle between impulsive choices, vs. a process for making rational decisions.

Without the tug of adrenaline and dopamine, you can stick to your original investing plan. That's actually the key problem with biochemical or hormonal decision-making: It's not that the decisions are necessarily so bad -- although they often are -- but even more significant, they derail your original investment plan.

As investors, you need a plan that allows you to save an adequate amount of money for retirement. We'll delve into this further in a future column but, suffice to say, the biggest problem with fear and greed is that in the blink of an endorphin, they can derail a well-thought strategy.

Think of this in terms of food: Imagine you are on a carefully crafted diet. You eat only healthful meals from a list of ingredients that have a good balance of carbohydrates and protein, with a limited amount of fat. Now consider an impulsive snack. What are the odds that this cheat will fit into your planned diet?

That's the key problem with emotional decision-making. When carefully designed strategies are supplanted by an impulsive choice, you have a recipe for poor performance.

As Malcolm Gladwell's best-selling book Blink: The Power of Thinking Without Thinking makes clear, unless you are an expert with decades of experience, instantaneous reactions can often have disastrous consequences.

To be sure, the study has an inherent bias in it: The experiment was designed so "risk-taking was the most advantageous behavior." The less-fearful participants made higher return investment decisions. In reality, people have a tendency toward risk-averse economic decision-making.

That aside, there are important lessons to be learned:
  • Do not allow your emotions to derail you from your plan;
  • Learn when risk-taking is an appropriate course of action;
  • It's not just the decisions, but the decision-making process that you can control.
  • Short of brain damage, there are ways to control the impact our emotions have on us as investors. Investors who do that achieve much better returns.

    1. Expect to Be Wrong 2. Your Fault, Reader
    3. The Wrong Crowd 4. Bull or Bear? Neither
    5. Know Thyself 6. Prepare for Battle
    7. Bite Your Tongue 8. Don't Speak, Part 2
    9. The Zen of Trading 10. The Folly of Forecasting
    11. Lose the News 12. Tracking Elephants, Pt 1
    13. Tracking Elephants, Pt 2 14. Nothing Doing
    15. Surviving Silly Season 16. The Zen of Trading
    Check back for more of Barry Ritholtz's
    Apprenticed Investor series
    Barry Ritholtz is chief market strategist for Maxim Group, where his research and market analysis are used by the firm's portfolio managers and clients in the U.S., Europe and Japan. He also publishes The Big Picture, his macro perspectives on the economy and geopolitics, entertainment and technology industries, and is a member of the board of directors of Burst.com, a streaming media software company. At the time of publication, Ritholtz had no position in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ritholtz appreciates your feedback; click here to send him an email.

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