A One Minute Self Assessment: A Rational or Emotional Decision
By Hans Bool

There are many ways in which emotions influence your investment decisions. This influence of (emotional) behavior on finance is a (not that of a) new branch of the finance theory.

Peter Bernstein calls this "new branch" or group the Theory police, "because they are constantly checking to see whether investors are obeying or disobeying the laws of rational behavior as laid down by the Bernoullis, Jevons, Von Neumann, Morgenstern and Markowitz." (Against the Gods, The remarkable story of risk)

Bernstein mentions the hypothesize of Shefrin and Statman referring to a split of the human psyche; "one side of our personality is an internal planner with a long term perspective, an authority who insists on decisions that weight the future more heavily than the present. The other side seeks immediate gratification. These two sides are in constant conflict"

The examples of this area of behavior finance focus on the decision process and the differences in weighting the various outcomes. Bernstein himself offers the example of companies that pay dividends and borrow money at the same time. So rather than taking rational decisions, the investor uses mental shortcuts. The gamblers fallacy, for example -- used in the behavior finance discussion -- will falsely predict the reversal of a trend.

So if -- and this is where the influence of behavior finance ends -- psychology is that important in finance, you should know which side of your brain rules your investments and when!

This is not always accurate, because the uniqueness of psychological situations do not allow the same accuracy that you might expect in finance. Yet, it shows you approach in this area; where do you think you stand; more emotional or more rational when to decide about the next investment?

Do you buy on the rumors in the market? Do you sell on the sole advice of a friend "with relevant experience?" Tipped by a Guru? Or do you set your own plan, and are you confident that this time, the market is wrong.

Try to setup such a profile for yourself. You do not even need a psychological model like Myers-Briggs to know the "exact" outcome, just picture yourself on this balance.

© 2006 Hans Bool

Hans Bool is the founder of Astor White a traditional management consulting company that offers online management advice. Astor Online solves issues in hours what normally would take days. You can apply for a free demo account

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