Path of smart investor starts at being aware of behavioural weakness

SMART investors try their best to make rational decisions. In the long term, investors will reap the benefits of a rational investment strategy. As Charlie Munger once said, it is a moral obligation to be rational.

Rationality and consistency are two sides of the same coin. However, to borrow from Daniel Kahneman, "humans are incorrigibly inconsistent in making summary judgments of complex information; when asked to evaluate the same information twice, they frequently give different answers".

There is now a rich body of evidence, gathered from tests performed on (so-called) experts across a wide range of fields (from medicine and finance to fine wine) to show that there are few circumstances under which it is a good idea to substitute judgement for a formula. This is particularly the case when dealing with complex scenarios with multiple possible future outcomes. Notable examples include mental accounting, asymmetrical loss aversion, herding, and narrative fallacies. These and many more are the watchwords of the discipline of behavioural finance, which has grown tremendously in importance over the past 30 years.