Investing Psychology: The Effects of Behavioral Finance on Investment Choice and Bias, + Website

CHAPTER 1

Sensory Finance

Wandering around inside the average investor's mind is very much like taking a tourist bus around Wonderland with the White Rabbit as a guide. Much that we think is obviously true turns out to be false and much self-evident nonsense is rather closer to reality than we could ever have thought.

We're going to start our tour in a place where everyone can “definitely” tell the difference between truth and falsehood, by looking at the way our senses interact with the world around us. Our ability to interact with the world and to learn from it allows us to extrapolate into the future, to make predictions and then to act on those predictions.

Unfortunately, the skills that serve us so well in everyday life combine to betray us in the topsy-turvy world of investing and finance. Our sensory system may keep us alive, but that's no guarantee it's going to make us rich.

BEATING THE BIAS BLIND SPOT

Although it's quite easy to convince people that we're biased in the way we perceive the world, it's very hard to persuade individuals that they are personally just as biased as everyone else. This is pretty irrational—how likely is it that you're the only unbiased person around? Yet there's an underlying reason for this belief and it says that we think we're better judges of the world around us than everyone else. Unfortunately, we're wrong and you are just as biased as me, and I'm just as biased as everyone else. Or I would be, if I hadn't spent a lot of time figuring ...