Decisiones de inversión bajo la lupa: Desenmascarando las trampas mentales

Making decisions is not easy and in investments it is even more difficult, because if a fund manager makes a bad decision, it has the potential to create a domino effect that will impact multiple stakeholders to the point of destroying their assets.

For these reasons, all managers should have the ability to make good decisions; however, much of the time this is not the case, as they are influenced by mental traps, better known as cognitive biases.

Thus, it is essential to understand where these traps come from. The biases stem from the Dual Thought Process Theory, which posits that our thought forms are divided between two systems: System X and System C. The first is the emotional part of the brain, processing information automatically and intuitively, on the other hand, the second system is the logical and deductive part, which handles information deliberately and analytically, moving forward one step at a time and to convince you that something is true, logical arguments and empirical evidence are needed.

Now, according to science, the best way to make sound decisions is through a rational process. However, although it is said that human beings are rational, it is not easy to make decisions without being affected by cognitive biases. It should be noted that, if you think you are better than others at avoiding these biases, let me tell you that you are already falling into two: the first is overconfidence, which leads you to overestimate your own abilities, and the second is the blind spot of bias, where you think you are less likely to suffer from them than others.

We have already understood that we are all prone to be victims of bias in any type of decision, but the aforementioned are not the only ones that affect us; there are many more. A practical case to identify others is when a manager evaluates the possibility of investing in a company’s assets.

To do this, it has to collect information; However, you must be careful not to fall into the illusion of knowledge bias, believing that more information is always better, but you have to consider the strength of how useful what you say is and the weight of who says it, otherwise, you can generate an excess of confidence, leading to bad results, since more information does not always mean greater accuracy in the forecast.

On the other hand, a lack of necessary information also leads to anchoring bias, where we cling to irrelevant data and our expectations depend on the initial information. Confirmatory bias is also related, as managers, when looking for additional data, tend to meet with company executives. However, these managers will only say what managers want to hear, overvaluing their company’s assets.

This is because managers are equally prone to pitfalls such as status quo bias, an example of the endowment effect, where more value is placed on something simply because it belongs to them. It is important to mention that both the status quo bias and the endowment effect are part of a more general problem known as loss aversion; In short, people dislike losses much more than gains.

These are just some of the many biases that exist, but jumping to when the manager has already made the decision and it is time to receive the results, whether good or bad, he must be careful not to suffer from the self-attribution bias, considering that a good result was due to his ability and a bad result due to bad luck. According to Montier (2007), if we compare our decisions and the reasons that have led us to make them with the results, we will be able to understand when we have been lucky, when we have used authentic skill and, most importantly, when we have made a mistake to learn from them.

Finally, it’s hard not to fall back into these biases, as System X is our default option. However, some ways to avoid them are by contemplating four premises established by Montier (2007): these prejudices affect us all, more information does not always mean better information, listen to those who disagree with you and examine your mistakes, because failures are not just a matter of bad luck.

References:

Montier, J. (2007). Behavioural Investing: A Practitioner’s Guide to Applying Behavioural Finance. Wiley

About the author:

Geisel Totolhua Flores is a student of the Bachelor’s degree in Banking and Investments at the Universidad de las Américas Puebla (UDLAP) and is currently part of the Honors Program. She serves as Director of Promotion and Development at the IMEF Universitario in the UDLAP Local Board of Directors, where she has been a national winner in the area. Previously, he obtained a diploma from the International Baccalaureate (IB) Diploma Programme, undertaking a monograph on economic issues as part of the programme requirements.

Contact: geisel.totolhuafs@udlap.mx