We all use mental shortcuts when we form opinions and make decisions. These shortcuts speed things up, but can also disrupt the balance between logic and emotion. This is called cognitive bias. In investing, a highly emotional activity, these biases, if left unchecked, can sabotage your results. Fortunately we have a great resource to help us recognize and overcome these complex biases. We want to share with you our favorite back of the napkin sketches from investment author Carl Richards of the NYTimes bestseller, Behavior Gap: Simple Ways to Stop Doing Dumb Things With Your Money. Carl, “The Sketch Guy”, is also a frequent columnist for the NYTimes.
Our favorite six napkins from The Sketch Guy: (Click to enlarge each sketch)
The Behavior Gap
Bad behavior predictably breeds poor investment returns. In a 20 year study, the research firm Dalbar found that while the S&P 500 clocked along at an 11.1% annual return, equity investors managed to realize a 3.7% annual return. Why? Because people get caught up in CNBC, Jim Cramer, and the crisis du jour. They buy when things feel good (high) and sell when things get painful (low).
When experts get together to predict the unpredictable, a few lucky ones can get it right. This is similar to the infinite monkey theorem where monkeys hitting keys on type writers will eventually compose Shakespeare. Beware of giving too much weight or credit to the experts.
Do You Want Action? or Results?
It’s human nature to act, especially when doing nothing feels like a missed opportunity. It’s important to recognize when doing nothing can actually be your best opportunity. Think trading versus a buy and hold strategy. Despite what your broker says, remember that action does not guarantee results.
You and Your Goals
Too often investors focus on the wild goose chase for the very best investment. Although well-intentioned, this tends to cost investors money. Developing an investment plan and sticking to it is a far more effective focus and approach.
…They Didn’t Have A Plan
We know that the markets go down. That’s just the nature of markets; they change like the weather. So why should we be surprised when it happens? Instead we should be prepared and have a plan in place for what you will do when it does happen.
Know How Much You Don’t Know
Small sample sizes can lead to unreasonable assumptions. Luck is often mistaken for skill, especially in investing. We calibrate our sense of risk based on our own experiences so don’t get caught up in making big investment decisions without getting the full picture. Being able to identify when you might be wrong could make all of the difference.
Want to see more? Here is a link to the Sketch Gallery.
Max Osbon – firstname.lastname@example.org
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