August 19

How to make successful investment decisions with 3 Mindsets

Decision Making, Investing

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Today let’s talk about investment decisions. I will use investment decisions to showcase the ability to work with Mindsets to achieve the best possible results. As a playground I am going to focus on investment decisions on the stock market. This blog post is the first part of a trilogy. ...

Just to clarify

Neither this post nor the trilogy itself is an investment advice nor any sort of push to invest money. Rather, the entire trilogy reflects my analysis of the emotional challenges of investment decisions in the markets.

We are not fair losers

Whoever wants to earn money from money has to first understand how losses work. To approach the topic of losses related to investment decisions, there is no way around the concept of loss aversion. This is a distortion in the perception of losses compared to gains. A 10.000€ loss hurts most of us more than 10.000€ of profit make us happy. The factor tends to vary between 1.5 and 4, which means 1€ lost money can be compensated by 1,50€ to 4€ in profits. A finding that everybody who is active on the stock market should know about. And a finding that was part of a theory for which Daniel Kahneman and Amos Tversky received the Nobel Prize for Economics in 2002.

Everything is (ir)rational?

Let me show you what the dilemma of loss aversion is all about. Let’s assume you have 10.000€ free capital, which you invest in a worldwide ETF expecting to generate 8% p.a. growth over a period of 10 years. A sound investment decision I’d say. Let's further assume that your personal loss aversion is 1:3. And let’s finally assume you invest 10.000€ at the time of the release of this blog post in August 2020 and the following development takes place (I briefly consult my crystal ball for investment decisions):

End of 2020

End of 2021

End of 2022

End of 2023

End of 2024

9.800€

6.500€

6.300€

8.200€

9.800€

200€

3.300€

200€

1.900€

1.600€

End of 2025

End of 2026

End of 2027

End of 2028

End of 2029

11.600€

15.000€

16.200€

16.900€

18.000€

1.800€

3.400€

1.200€

1.200€

1.100€

Summary financial account

Nominal gains: 11.700€

Nominalal loss: 3.700€

Nominales result (Balance): 8.000€

Investment decisions from a numbers perspective: System 2

We can see that our €10,000 invested capital went up to €18,000 at the end of the 10 years period, which represents an 80% increase and an annual growth rate of 6.1%. This is 1.9 percentage points below the expected average of 8% p.a., but hey, 6.1% return is way better than what classical interest rate investement has to offer. And I’m fairly comfortable with this statement for the entire period up to the year 2029.

Investment decisions from an emotional perspective: System 1

Now it gets interesting, because in contrast to the previous calculation, I’d say that more than 99% of people do not make the following calculations ahead of their investment decisions. In my opinion that's a mistake for many people, especially those with only limited experience of ups and downs in the market.

Let's take a profit of 100€ as a baseline and assign an emotional reward of 100€ to it. Based on a loss aversion of 1:3, this means that a loss of 100€ corresponds to an emotional reward of 300€.

While our portfolio has climbed from 10.000€ over the low point of 6.300€ to 18.000€ (+80%) within10 years, our emotional accounting looks like this:

End of 2020

End of 2021

End of 2022

End of 2023

End of 2024

9.800€

6.500€

6.300€

8.200€

9.800€

600€

9.300€

600€

1.900€

1.600€

End of 2025

End of 2026

End of 2027

End of 2028

End of 2029

11.600€

15.000€

16.200€

16.900€

18.000€

1.800€

3.400€

1.200€

1.200€

1.100€

Summary emotional account

Emotional reward: 11.000€

Emotional suffering: 11.100€

Emotionales result (Balance): 100€

It's obviously true that after 10 years this emotional loss still means 8.000€ nominal increase in value, which should be a good result for most of us even after deducting inflation. But here is the key problem: Most investors would have already sold their investment in 2021.

System 1 or 2: Who prevails when it comes to investment decisions?

To invest money successfully on the stock market, we need full access to our System 2, which includes our capability for logical thinking and discipline.
However, our decision-making does not only consist of conscious processes, but also of a wide world of unconscious (System 1) processes. For those who want to read a simple introduction about these two Systems, I recommend my “4-Stays-Here-Method“ blog post.

Investment decisions
An investment decisions should never lead to sleep problems


While on a logical, rational level we can assume that the large losses in 2021 will be recovered steadily in the coming years, emotionally speaking we will go broke in 2021. Since our System 1 contains a deeply rooted protective function encoded into our brain, a strong impulse to save the remaining money by withdrawing it kicks in. System 1 takes over. And it doesn't need much time to act. This effect has been empirically confirmed many times over, even though logically speaking it is the most stupid move of all when it comes to investment decisions in the long run.

In the next part of this triololgy about investment decisions, I’ll talk about three distinct Mindsets that form the basis of successful investing.

  • Have you ever dealt with your own specific loss aversion?
  • If so, how strong is your loss aversion and have you observed any changes over time?
  • What is your view on investing money?

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