Are you an investor who is "cognitively challenged"?

We can use the phrase "cognitively challenged" as a polite way of saying that investors and traders have significant behavioral biases. Investors are "special" when it comes to making decisions. Investor are not any more special than decision-makers in general, but investors are suppose to follow  rational behavior.

In reality, they do not follow the well-defined ideal rules of expected utility maximization. The investment world has harped on the issues of decision biases making many investors feel challenged, but there has been little to help explain whether these biases truly have any rational basis.

It is unfortunate that decision theory has focused on the negative deviations from rationality. It makes us all sound as though we are damaged thinkers when faced with decisions. This actually may not be the case. There is hope for us decision-makers if we describe our behavior in a more nuanced manner.  We choose certain behavior because it may be a good alternative to the ideal expected utility maximization model.

Think of what it takes to undertake a expected utility maximization. You need to know all of the states of the world and you need to the know the likelihood of them actually occurring. You multiple the state times the probability to get an expected return. You also have to know yourself and the level of risk aversion you have at any point. All of this is doable and makes sense in a perfect world, but we do not live in a world that is anything close to being perfect; consequently, we have to make compromises. Is this irrational?

The concept of fast and slow thinking as presented by Daniel Kahneman is not about flawed thinking but about how we think giving different types of problems and information. The one-size fits all behavior of expected utility maximization makes an investor cognitively challenged because it may be overkill in certain situations. The cognitive challenge is learning to apply the right methodology for the problem faced.

There is no denying the fact that there are behavior biases with investors but some of the heuristics used by investor to deal with fast problems and uncertainty is good cognitive decision-making.