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How Thinking
Affects Investing

How to Think Clearly and
Invest Well

To be a good investor, you must, over time, acquire skill and knowledge. To become a successful investor, however, requires more. You must be able to make good decisions consistently, month after month after month.

Like a pilot who learns how to depend on his instruments, you must train yourself to think clearly and logically at all times. This requires you to base your financial decisions on rational thinking, not on your feelings or intuition.

The easiest way I know to develop these habits is to apply your knowledge of heuristics and cognitive biases every time you find yourself making a financial decision. Eventually, this will eliminate distortions from your decision making, at which point thinking clearly about your investment activities will become second nature. Here is how to do it.

Whenever you find yourself making a financial decision, no matter how small, go through the following checklist, one item at a time.

List of heuristics and cognitive biases

  1. False Analogies to the Physical World
  2. Representation Bias
  3. Loss Aversion
  4. Endowment Affect
  5. Disposition Effect
  6. Sunk-cost Effect
  7. Anchoring
  8. Confirmation Bias
  9. Cognitive Dissonance
  10. Bounded Rationality

For each item, recall the nature of the bias. (To remind yourself of the details, simply refer to the summary in the previous section.) Then ask yourself:

"Right now, is this particular bias affecting my decision making?"

If you are honest, you will often realize that your thoughts are distorted. When this happens, simply revise your ideas, and try again. I promise you, once you can get through the entire checklist, and you honestly feel confident that none of the biases are affecting your thinking at that moment, you will be happy with your decision.

Eventually, as you train yourself to avoid the cognitive biases that plague financial decision-making, you will find that, more and more, you are able to think carefully and act prudently, especially under pressure.

When that day comes, you will be a successful, confident investor.

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