Investors: Protect Yourself from Mental Biases

make yourself behave in rational ways. Just promising to be good is not good enough. The road to hell is paved with good intentions.

Here are some of my favorite tools that can help you guard against mental biases, shortcuts, and the like.

Use Checklists

Checklists are an easy way to force yourself into structured thinking and you will find them throughout this list. You should treat every important checklist as an extension of your mind, and it should be continuously evolving. Checklists have to be simple enough to be useful, while capturing all important elements in an appropriate way. Adding to your list is not always the best way to improve. For example, resorting and shortening the list could make you more effective. You should have a checklist for all important activities that you perform on a consistent basis. Even the most experienced pilots and surgeons still go through their checklists every time they perform an important procedure. An investor would at least have a checklist for mental biases, an investment checklist, a list of mental models, a checklist for networking meetings, and checklists for various other business processes.

Checklists protect you from several mental biases, especially errors of omission, because they force you to go through items systematically without being allowed to skip one. Lists should help you to counter doubt-avoidance tendency, inconsistency avoidance tendency, but most notably availability-misweighing tendency among other biases.  Even though it feels uncomfortable, after going through your checklist you will often find that important information pieces are simply not available to reach a truly informed decision and you will have to find a way to get comfortable with a greater degree of uncertainty than you originally hoped for when predicting outcomes.

Slow Down

The reptilian brain is often associated with thinking quickly, whereas the rational thought process is deliberately slow (see Kahneman Thinking Fast and Slow). Kahneman makes the interesting insight that humans use a combination of both systems to reach decisions, but are utterly ignorant about the great degree to which they actually use the reptilian brain, wrongly considering themselves more rational than they actually are.

The irrational brain is instinct driven, reactionary, and is resorted to when quick decision-making is required. Often times, a short-cut of some sorts is required, as perfectionists would never reach a decision because an optimal solution can often not be determined. We have to accept that we make imperfect decisions based on incomplete information (see Herbert Simon “Satisficing”), and accept the trade off between reaching a decision and making a decision on the ground of incomplete information.

So for once, accept that you are using your “irrational” decision making apparatus as a necessity. Be aware why and how you are applying mental short-cuts. Recognizing your own propensity to being biased is a recurring theme in this list. Second, slow down the thought process deliberately. Defer decisions, sleep over every big decision at least one night. Take your time to go through your mental routines, and don’t let yourself be easily pressured into early decisions.

An additional helpful tool can be that you schedule time to deliberately think slowly about a problem at a time. Scheduling time to focus on one particular problem, and knowing that the time is dedicated to this problem only, will help take stress of your brain and think more clearly. You don’t want to have something in the back of your mind that distracts you from focusing. “Getting Things Done” by David Allen is a wonderful book that can help you think more clearly by structuring your work and dedicating efforts to a problem at a time.

Use a Checklist of Biases

An absolutely essential tool for guarding against biases is reflection. You want to keep an evolving list of heuristics and go through the list item by item to try to understand how a particular bias influences your perspective and decision-making. Accept that you are almost always taking mental shortcuts. Try to answer: What mental shortcuts are you taking, why are you taking them, and what can be done about them? This checklist can be used in retrospect to evaluate on past decisions, but my favorite time to go through the list is just after the point where  I think I have reached a decision. At this point, I will step back, go through my checklist, and reevaluate in lights of my biases.

If you are just starting to compile a list of biases, it is probably a good idea to initially adopt material that is already out there. Charlie Munger’s list of standard causes for human misjudgment is a great starting point. Several bloggers, like Shane Parrish, have also accumulated impressive lists of biases and mental models you can use.

Recognizing that you are biased is by no means the only step. You want to adjust your behavior according to your new insights. Often times, after recognizing that have fallen victim to a bias, you want to go back and collect additional information, adopt a new perspective, or maybe seek additional disconfirming evidence. Sometimes, you can identify the source of a bias and remove it. For example, you could cut yourself off financial media if the noise from experts is distracting you. The point is: let action (or inaction) flow from your newly gained understanding.

Keep a Diary

A decision diary (or for an investor, an investment diary) is another useful tool that makes reflection more objective, helps you guard against hindsight bias, and helps you improve by analyzing past thought processes.

Humans are bad at understanding and predicting their past and future points of view, and unless you are Mr. Spock, you are too. When evaluating past decisions, you want to evaluate them in light of the available information at the time. In your diary, write down as simply as you can why you reached a certain decision, what information you considered and how you weighed the information pieces.

Describe the thought process in your decision diary, and always make your diary entry as soon as possible. Don’t wait weeks after a decision to make your diary entry. It might be useful to not only write down the decision that you made and why you made them, but also the decisions you did not make and why you shied away or deferred. Another useful feature of your decision diary could be that you write down different scenarios that you could imagine developing from that point. Visualize them, and attach probabilities. Make a pre mortem before the decision; think of a range of good and bad states a couple of years down the road and write down what your explanation for the outcome would be. Through addition of these features, a periodic review of your decision diary will be more educational, but also more painful.

You will overcome the “I knew it” default reaction when you see a stock going up that you looked at before, and probably spend fewer sleepless hours over missed opportunities. Sometimes, you might fail to make sense of your own notes, and sometimes you will be embarrassed by the stupidity of the thought process laid out by your past self. These might be necessary concomitants of honest self-reflection (see George Soros’ investment diary in Alchemy of Finance).

“What could I have done differently?” is