“…the investor’s chief problem and his worst enemy is likely to be himself.”
The Johari Window was designed to help people better understand their relationship with themselves and others. Created in the ‘50s by two psychologists, it’s main function is for self-help groups. You pick from a number adjectives and insert them into the boxes that you believe fit your personality best, your peers do the same, and then you compare. If you’re super interested, you can read more here.
But we can’t help but look at the Johari Window and think Black Swans, behavioral finance, and Stevie Cohen. It seems like a great metaphor/prism with which to view investment decisions and allocations.
Here’s our attempt at the investors Johari Window:
Now, we typically build portfolios to consider the known to you/known to me. I know how much money I have, I know how long I have until college or retirement, or whatever. I (think I) know the return and risk profile of what I’m investing in.
A little more advanced approach, especially for those who add alternative investments to the portfolio, is to also allocate based on the unknown to you/unknown to me, adding something like managed futures which have tended to do well in past crisis periods brought on by black swan events which were (sort of) unknown unknowns (although we could argue that the credit crisis was a known unknown).
The part we perhaps should spend more time on is the top right box, the unknown to you/known to me. We’ve outlined a few examples of these, like few Robinhood investors (and now Etrade, TD, and all the rest) knowing that the reason they get free commissions is because their orders are sold to the highest bidder so some firm can trade against that information. But that lack of knowledge doesn’t necessarily injure your return stream.
What can injure your investment returns are the more nuanced dangers of the top right corner – the blind spots it represents in your investment thesis. The danger to a portfolio is an unnecessary risk. Something we don’t know, but should. Something we haven’t protected the portfolio from, or have skewed the portfolio towards, because of our human blind spots, or biases. Behavioral finance is littered with these biases, as outlined by Barry Ritholtz here:
- Herding, Groupthink
- Expert Fallacy
- Optimism Bias
- Confirmation Bias
- Recency Effect
- How Emotions Impact Perception
- Anticipation vs. Rewards
- Selective Perception & Retention
- A Species of Dopamine Addicts
- Ownership’s Endowment Effect of
- The Narrative Fallacy
- How Cognitive Errors Impact Processes
What do you do about it? Well, as they say, admitting you have a problem is the first step. Understanding these biases in your thinking on investments and applying reality checks, additional due diligence, and a Johari window of sorts is the next step. Identify your blind spots in the portfolio, before they come looking for you!