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Stop. Think. Invest.: A Behavioral Finance Framework for Optimizing Investment Portfolios
Use the power of behavioral finance to make smarter, better-informed decisions through every step of the investing process
In an economy where markets are more unpredictable than ever, emotions can derail the efforts of even the most experienced investors and wreak havoc on portfolio returns.
Applying powerful behavioral finance concepts, Stop. Think. Invest. provides a framework for identifying personal biases and avoiding mistakes that can cost big profits. Based on the author’s extensive research and 100 key behavioral finance concepts, this guide provides a winning 12-step process you can use to successfully manage your trading and investing for long-term success,
Begin the initial research into a new stockCreate an investment thesis—why are you buying the stock?Trade timing and size—when are you buying and how much?Make the initial purchaseReview the trade—round up or round downTest your original investment thesis
Stop. Think. Invest. reveals critical information about behavioral finance flaws, such as anchoring, confirmation bias, recency bias, and loss aversion.Unlike other behavioral investing guides, Stop. Think. Invest. offers a fully organized and practical approach to applying behavioral finance to everyday investing.
In an economy where markets are more unpredictable than ever, emotions can derail the efforts of even the most experienced investors and wreak havoc on portfolio returns.
Applying powerful behavioral finance concepts, Stop. Think. Invest. provides a framework for identifying personal biases and avoiding mistakes that can cost big profits. Based on the author’s extensive research and 100 key behavioral finance concepts, this guide provides a winning 12-step process you can use to successfully manage your trading and investing for long-term success,
Begin the initial research into a new stockCreate an investment thesis—why are you buying the stock?Trade timing and size—when are you buying and how much?Make the initial purchaseReview the trade—round up or round downTest your original investment thesis
Stop. Think. Invest. reveals critical information about behavioral finance flaws, such as anchoring, confirmation bias, recency bias, and loss aversion.Unlike other behavioral investing guides, Stop. Think. Invest. offers a fully organized and practical approach to applying behavioral finance to everyday investing.
374 pages, Kindle Edition
Published January 4, 2022
2 people are currently reading
57 people want to read
About the author
Michael Bailey
128 books68 followersMichael Bailey is a recipient and ten-time nominee of the Bram Stoker Award, a five-time Shirley Jackson Award nominee, and a three-time recipient of the Benjamin Franklin Award, along with several independent publishing accolades. He has written, edited, and published many books of various genres. His latest is Righting Writing, a nonfiction narrative used as curriculum for aspiring writers, and Silent Nightmares: Haunting Stories to Be Told on the Longest Night of the Year, an anthology co-edited with Chuck Palahniuk to be published by Simon & Schuster in fall of 2026. He is also the screenwriter for Madness and Writers, a creative documentary series about writers, and a producer for numerous film projects. Find him online at nettirw.com, or on social media @nettirw. He is represented by Lane Heymont of the Tobias Literary Agency.
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April 26, 2022Within the investment cycle of researching options, picking a stock, analyzing progress, and figuring out when – and when not – to sell, there are a number of behavioral and psychological factors at play. Biases, fears, and influences both internal and external can cause investors to make bad decisions every step of the way. This is the realm of behavioral economics – and recognizing these factors can help you avoid pitfalls, keep a clear head, and make decisions based less on emotions and more on real-world evidence and insights.
And here’s some more actionable advice:
Ask yourself four questions when researching potential stock picks.
The behavioral economist and Nobel laureate Richard Thaler came up with four questions to ask yourself when looking at a company. They are, “Who uses? Who chooses? Who pays? Who profits?” In other words, who’s using the product or service? Who’s choosing which products and services are being offered? Who are the customers or clients paying for these things? And who’s profiting – where is that money going? A lot of the time, these answers aren’t so clear-cut. But if you ask them regularly and do the hard work of finding answers, you’re bound to come away with a much better understanding of how the company operates – and whether it’s one you feel confident investing in.
---
Narrow down your options with a mix of libertarian and paternal approaches.
Before we get into the nitty-gritty, let’s take a big-picture overview of the investment cycle. At its most basic level, investing is a process that involves the following: looking for new ideas, researching companies, mapping out your long-term expectations, deciding on the timing and size of your investment, making a purchase and analyzing the results, considering when or when not to sell, reevaluating your expectations, and focusing on learning and improvement.
With that in mind, let’s start with the steps of looking for new ideas and researching businesses. There’s no lack of options when it comes to investing. In fact, there are way too many out there to really consider them all. This is why the first investment tip is about how, sometimes, less is more.
Some of the more traditional economic theories suggest that the more choices consumers have, the better off they are. But this isn’t necessarily the case. It’s not hard to reach a point where an abundance of choices can lead to what behavioral scientists call the paradox of choice. Basically, this is what happens when there are so many options that it becomes virtually impossible to make a decision.
In his book Nudge, author and Nobel Prize–winning economist Richard Thaler talks about the role of a choice architect. This is an expert who can come into a situation and help teams and organizations who are facing a paradox of choice make better decisions. The process here is all about narrowing things down. Eliminating choices. Giving yourself fewer options.
How exactly do you do that? According to Thaler, through a combination of libertarianism and paternalism. In this context, being libertarian means being open-minded – open to all ideas and free of opinions or biases that might blind you from the perfect investment opportunity. However, after you’ve looked at things with an open mind, you’ll need to narrow them down by exerting a certain amount of paternalism. That entails using your knowledge and exerting your influence to guide the selection process in a certain direction.
Now, all of the advice we’re considering here is about long-term investments – not stocks you buy in the morning and sell in the afternoon for a quick profit. So, as a general rule of thumb, Bailey recommends seeking out stocks that have the potential to beat, or outperform, the market. One specific thing Bailey looks for when stock-picking is something he calls “secular change.” This might be a company that has changed management, made a sizable acquisition, created a new division, or perhaps launched a new product campaign. Secular change is not always apparent – but it has the potential to increase the value of a business and create the kind of beat-the-market opportunity you should be looking for.
So let’s put this concept of libertarian paternalism into action, and look at how it led Bailey to discover a new investment opportunity. In 2016, Bailey took an open-minded, libertarian approach to looking for new long-term investment ideas. This led him to explore options like cloud computing, cyber security, and self-driving cars. From there, he shifted to a paternalistic approach and took a close look at these three different ideas. Self-driving cars still seemed a little too high-risk at the time. As for cloud computing, he already had holdings in Microsoft and Google – so he felt he had this trend covered. He narrowed it down to cyber security, an area that would likely continue to have long-term relevance in the market. This, in turn, led him to Palo Alto Networks, a company that was big enough to already be generating profits, but small enough that it could conceivably undergo change and rapid growth in the near future.
Finding these opportunities isn’t exactly child’s play. It takes effort, which brings us to the next step: research.
---
Don’t let external influences like media noise push you to sell too early.
Let’s say you’ve done your research, written your thesis, consulted with the committee, and – without any further procrastination – made your initial purchase. Now what?
Well, now it’s time to monitor and analyze the early results. But beware: this part of the process is also full of pitfalls related to human behavior.
It’s likely that your new investment will get off to a bumpy start. It might drop sharply before it takes off and successfully beats the market in the long-term. So it’s important to keep things like loss aversion in mind. Remember that two-to-one ratio in which people feel disproportionately bad about losing a small amount of money? This kind of aversion has led many investors to making bad decisions in difficult times – and that’s precisely what we want to avoid.
When something goes wrong, it’s easy for System 1 thinking to take over; you might latch on to the obvious and easily available information and make a rash decision. The key here is to fight back against that kind of reaction and engage in big-picture System 2 thinking. Take a deep breath. Now’s the time to keep a cool head and really figure out what’s going on. Sure, the stock took a tumble. But instead of hitting the ejector seat button, let’s figure out why it took a tumble.
There are a number of reasons why a stock could hit a rough patch. One common and unfortunate cause is the media echo chamber. A small, insignificant problem may arise and get reported on – which then causes a significant sell-off. This sell-off can snowball into another news item, which in turn fans the flames of panic even further. If you can recognize this particular feedback loop when it occurs, you’ll gain some reassurance that the initial problem was, in fact, minor – and not cause for alarm.
One good example of this involved stock in health insurance companies ahead of the 2016 US presidential elections. There were rumblings that Elizabeth Warren might win the presidency and overhaul the American health-care system. This caused concern that a single-payer program would be installed, making health insurance companies go bust. As a result, many people unloaded their stocks. Cooler heads recognized the plausibility and understood why the prices in heath insurance stocks were falling – but they also saw that the likelihood of all of those dominoes falling was pretty small.
Even a recession can be weathered. (By the way, here’s where a good investment thesis can once again come in handy!) In 2007, just before the major global recession, Bailey bought stock in a medical device company called Covidien. When Bailey bought into Covidien, it had just spun off from Tyco, a major conglomerate. This meant that Covidien was in a great position to experience rapid growth. While Covidien entered some choppy waters early on as the recession hit, that didn’t necessarily change the thesis. Medical device technology was still on track to play a big role in the future, and Covidien remained in a perfect position to outperform the market. So despite some concerned voices around him, Bailey stayed with the company. And it did indeed outperform for a number of years – before eventually being bought by Medtronic in 2015.
And here’s some more actionable advice:
Ask yourself four questions when researching potential stock picks.
The behavioral economist and Nobel laureate Richard Thaler came up with four questions to ask yourself when looking at a company. They are, “Who uses? Who chooses? Who pays? Who profits?” In other words, who’s using the product or service? Who’s choosing which products and services are being offered? Who are the customers or clients paying for these things? And who’s profiting – where is that money going? A lot of the time, these answers aren’t so clear-cut. But if you ask them regularly and do the hard work of finding answers, you’re bound to come away with a much better understanding of how the company operates – and whether it’s one you feel confident investing in.
---
Narrow down your options with a mix of libertarian and paternal approaches.
Before we get into the nitty-gritty, let’s take a big-picture overview of the investment cycle. At its most basic level, investing is a process that involves the following: looking for new ideas, researching companies, mapping out your long-term expectations, deciding on the timing and size of your investment, making a purchase and analyzing the results, considering when or when not to sell, reevaluating your expectations, and focusing on learning and improvement.
With that in mind, let’s start with the steps of looking for new ideas and researching businesses. There’s no lack of options when it comes to investing. In fact, there are way too many out there to really consider them all. This is why the first investment tip is about how, sometimes, less is more.
Some of the more traditional economic theories suggest that the more choices consumers have, the better off they are. But this isn’t necessarily the case. It’s not hard to reach a point where an abundance of choices can lead to what behavioral scientists call the paradox of choice. Basically, this is what happens when there are so many options that it becomes virtually impossible to make a decision.
In his book Nudge, author and Nobel Prize–winning economist Richard Thaler talks about the role of a choice architect. This is an expert who can come into a situation and help teams and organizations who are facing a paradox of choice make better decisions. The process here is all about narrowing things down. Eliminating choices. Giving yourself fewer options.
How exactly do you do that? According to Thaler, through a combination of libertarianism and paternalism. In this context, being libertarian means being open-minded – open to all ideas and free of opinions or biases that might blind you from the perfect investment opportunity. However, after you’ve looked at things with an open mind, you’ll need to narrow them down by exerting a certain amount of paternalism. That entails using your knowledge and exerting your influence to guide the selection process in a certain direction.
Now, all of the advice we’re considering here is about long-term investments – not stocks you buy in the morning and sell in the afternoon for a quick profit. So, as a general rule of thumb, Bailey recommends seeking out stocks that have the potential to beat, or outperform, the market. One specific thing Bailey looks for when stock-picking is something he calls “secular change.” This might be a company that has changed management, made a sizable acquisition, created a new division, or perhaps launched a new product campaign. Secular change is not always apparent – but it has the potential to increase the value of a business and create the kind of beat-the-market opportunity you should be looking for.
So let’s put this concept of libertarian paternalism into action, and look at how it led Bailey to discover a new investment opportunity. In 2016, Bailey took an open-minded, libertarian approach to looking for new long-term investment ideas. This led him to explore options like cloud computing, cyber security, and self-driving cars. From there, he shifted to a paternalistic approach and took a close look at these three different ideas. Self-driving cars still seemed a little too high-risk at the time. As for cloud computing, he already had holdings in Microsoft and Google – so he felt he had this trend covered. He narrowed it down to cyber security, an area that would likely continue to have long-term relevance in the market. This, in turn, led him to Palo Alto Networks, a company that was big enough to already be generating profits, but small enough that it could conceivably undergo change and rapid growth in the near future.
Finding these opportunities isn’t exactly child’s play. It takes effort, which brings us to the next step: research.
---
Don’t let external influences like media noise push you to sell too early.
Let’s say you’ve done your research, written your thesis, consulted with the committee, and – without any further procrastination – made your initial purchase. Now what?
Well, now it’s time to monitor and analyze the early results. But beware: this part of the process is also full of pitfalls related to human behavior.
It’s likely that your new investment will get off to a bumpy start. It might drop sharply before it takes off and successfully beats the market in the long-term. So it’s important to keep things like loss aversion in mind. Remember that two-to-one ratio in which people feel disproportionately bad about losing a small amount of money? This kind of aversion has led many investors to making bad decisions in difficult times – and that’s precisely what we want to avoid.
When something goes wrong, it’s easy for System 1 thinking to take over; you might latch on to the obvious and easily available information and make a rash decision. The key here is to fight back against that kind of reaction and engage in big-picture System 2 thinking. Take a deep breath. Now’s the time to keep a cool head and really figure out what’s going on. Sure, the stock took a tumble. But instead of hitting the ejector seat button, let’s figure out why it took a tumble.
There are a number of reasons why a stock could hit a rough patch. One common and unfortunate cause is the media echo chamber. A small, insignificant problem may arise and get reported on – which then causes a significant sell-off. This sell-off can snowball into another news item, which in turn fans the flames of panic even further. If you can recognize this particular feedback loop when it occurs, you’ll gain some reassurance that the initial problem was, in fact, minor – and not cause for alarm.
One good example of this involved stock in health insurance companies ahead of the 2016 US presidential elections. There were rumblings that Elizabeth Warren might win the presidency and overhaul the American health-care system. This caused concern that a single-payer program would be installed, making health insurance companies go bust. As a result, many people unloaded their stocks. Cooler heads recognized the plausibility and understood why the prices in heath insurance stocks were falling – but they also saw that the likelihood of all of those dominoes falling was pretty small.
Even a recession can be weathered. (By the way, here’s where a good investment thesis can once again come in handy!) In 2007, just before the major global recession, Bailey bought stock in a medical device company called Covidien. When Bailey bought into Covidien, it had just spun off from Tyco, a major conglomerate. This meant that Covidien was in a great position to experience rapid growth. While Covidien entered some choppy waters early on as the recession hit, that didn’t necessarily change the thesis. Medical device technology was still on track to play a big role in the future, and Covidien remained in a perfect position to outperform the market. So despite some concerned voices around him, Bailey stayed with the company. And it did indeed outperform for a number of years – before eventually being bought by Medtronic in 2015.
March 16, 2022
I thought this book provided a little bit different perspective compared to other behavioral economics books given the authors background as an investor.
This is a useful read for those in the finance field.
This is a useful read for those in the finance field.
March 17, 2022
I don't invest in individual securities, but I did find some of the information applicable to what I do.
September 18, 2022
Interesantă doar daca vrei sa îți mai amintești cate ceva, dar inutilă daca deja știi principiile de baza ale investițiilor în piața de capital.
Displaying 1 - 4 of 4 reviews