The Behavioral Continuum: What’s the Best Behavioral Bias?

Research into behavioral finance has raised awareness about humanity’s bounded rationality as well as the many quirks in our thinking patterns. Advances in neuroeconomics have helped us better understand — indeed, even measure — the biological connections between thoughts and actions. Much of the content on behavioral finance, however, carries with it an unnecessary negative spin.

The behavioral and thought patterns that influence our decision-making processes, whether finance-related or otherwise, are often cast as irrational and ultimately counterproductive, the result of illogical short-circuits in our reasoning.

It’s easy to forget that the complicated interplay among our emotions, thinking patterns, and actions is driven by a finely tuned 100-billion neuron network that has helped us to survive and evolve as a species. Thinking patterns are useful aids not just for dealing with mundane, day-to-day activities, investment decision making among them, but have also inspired revolutionary progress and innovation.

The Behavioral Continuum

Behavioral patterns extend across a wide continuum. On the darker side, they can generate negativity or lead to disaster. On, the lighter side, they are useful, even essential. Consider optimism. Optimism lies on the negative end of the behavioral continuum and can morph into a bias toward overconfidence. An overly bright outlook will inevitably contribute to sub-optimal and sometimes disastrous investment decisions. An abundance of optimism helped create the 2008 financial crisis. But there is an optimism paradox. As Dan Ariely points out, the bias has its benefits too, spurring investment in new companies and start-up ventures — the sort of enterprises that can catalyze transformative growth and the associated returns.

Being mindful about the structure and continuum of these patterns — and their potential paradoxes — is critical for investment decision makers, who interpret sometimes ill-formed and increasingly complex information inputs, frequently under pressure. Perceiving the true nature of these inputs, given the vulnerability and structure of the biases, is an important skill set to develop.

Like optimism, other behavioral patterns can be useful anchors for successful investment decision making. So which of these patterns is the most useful?

We polled readers of CFA Institute Financial NewsBrief to find out.

Which of the following behavioral biases is the most useful for successful investment decision making?

Skepticism

Of the 792 votes, an overwhelming 72% of respondents said that skepticism was the most vital. Skepticism is the ability to doubt, to question, and — hopefully — to investigate. By definition, skepticism is on the opposite end of all belief perseverance and information-processing biases. From the seven distinct types of emotional biases too, skepticism helps to keep emotions on a tight leash. Skepticism, to the extent that it contributes to inaction, is a bit closer to the self-control bias. A lack of self-control is an emotional shortcoming that misaligns short-term actions as they relate to achieving long-term goals. While an abundance of skepticism can lead to paralysis, healthy and consistent skepticism is largely beneficial.

Many top investment practitioners emphasize this, citing a healthy degree of skepticism as a critical quality. In his book Gurus of Chaos, Saurabh Mukherjee, CEO of institutional equities at Ambit Capital, identified a catalog of traits that can help investors deliver outstanding returns, and skepticism and curiosity are at the top of the list.

Optimism

Optimism was judged the most useful bias by 16% of the poll respondents. As the optimism paradox demonstrates, optimism has both benefits and drawbacks. As a group phenomenon, optimism and its counterpart, pessimism, are key contributors to booms and busts.

Status Quo

A relatively small percentage (7%) of readers opted for the status quo bias, which is the desire to extend existing conditions. On the positive side, such a bias reduces portfolio churn. On the negative side, it results in missed opportunities and delayed action.

Pessimism

Interestingly, pessimism attracted the least (5%) support. Pessimists tend to behave as if the worst-case scenario is inevitable, a quality that has obvious downsides. But pessimists are often detail oriented and can play constructive devil’s advocate roles in investment decisions. In terms of the behavioral continuum, too much skepticism can actually devolve into pessimism.

Self-Aware Thinking

Can investment decision makers stay on the right side of all behavioral patterns simultaneously? To do so, agile, self-aware thinking is essential. As Nobel laureate Daniel Kahneman noted in Thinking, Fast and Slow, investment success over the long-term requires both luck and specialized skills. Balanced, self-aware thinking can contribute to that. At the very least, it will help you avoid mistakes.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.