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Investing On Empty

In this article, Cameron Hight references a piece titled ‘Tired Investing’ by Cabot Research, which walks through how our decisions are influenced by our state of mind.

How do we make portfolio decisions? How do you ultimately make the decision to buy IBM and not Dell? To make Google a 4% position and Microsoft a 2% position? To add to Apple and trim some Oracle? Could we write down or explain to someone exactly how you made these decisions? Most likely not because they required a good dose of experience-based intuition. Well a good article titled ‘Tired Investing’ by our friends at Cabot Research, walks through how our decisions are influenced by our state of mind.

Excerpt from ‘Tired Investing’ by Cabot Research:

While your intuition and judgment may be spectacular they rely on a limited and easily depleted reservoir of psychic energy and this presents serious risk that most managers do not factor into their decision making. Baumeister brings this point home with the following: "The ease with which we have been able to produce ego depletion using small laboratory manipulations suggests that the extent of the resource is quite limited, which implies that it would be seriously inadequate for directing all of a person's behavior, so conscious, free choice must remain at best restricted to a very small proportion of human behavior."

For portfolio managers the lesson is clear: Your best may be terrific but you can't count on being your best at every junction without help. And the support top managers employ is their investment process. Knowing when to slow down, think twice, benchmark to outside views and seek independent input are some of the process elements that guard against ego depletion, as well as a host of other emotional and cognitive biases.

Investment decisions can pop up at any time throughout the day. What precedes them, we now better understand, can dramatically alter the choices made and their impact on performance.

Experience enables managers to develop judgment and self awareness that can help counterbalance the effects of ego depletion. Adherence to a well calibrated investment process, however, can guide frenetic inter-day decisions towards choices that more often reflect intention, consistency and quality. The alternative may lead you towards tired performance.

Interestingly the best method to counteract the effects of poor decisions made from mental exhaustion is to create a process for decision making. This is Alpha Theory’s bread-and-butter. “Why did I decide to buy IBM and not Dell?” – well it is right there in Alpha Theory. “Why Is Google a 4% position and Microsoft a 2%?” – that’s also right there in Alpha Theory. Process isn’t a panacea for making the right decision but it sure can help avoid the wrong decision.

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