Investing with Blinders On

The current frontier of investing, the one that poses the greatest threat to the Efficient Markets Hypothesis (EMH) is Behavioral Finance.  The EMH is based on the concept of homo economicus, or rational man.  Rational Man is like Commander Spock.  He always acts without emotion and for his own self interest.  He never freaks out and sells stocks at their lows.  He’s able to forecast earnings perfectly, etc.  Behavioral Finance recognizes that real investors don’t act that way.  Exhibit number one might be investment bubbles, whether they involve tulips or internet stocks. 

In the course of developing this school of thought there have, naturally, been a lot of names given to theories.  One that I like a lot is called “Confirmation Bias.”  It’s the tendency to look only for information that supports one’s position.  It’s pros, not cons.  Avoid it, and you’re well on your way to making better decisions–in investing, and elsewhere.

Here’s a nice Wall Street Journal interview with one of its columnists on the subject.

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