What Does It Mean for Investors to Think Critically?

The rapidly rising field of behavioral finance has had an enormous impact on investing. One thing it's taught investors is how important it is to slow down  and think critically when deciding whether to buy or sell a stock.

In this segment of Industry Focus: Financials, The Motley Fool's Gaby Lapera and John Maxfield dig into one component of critical thinking -- namely, how to assess and sort through the vast amount of information available to us in a way that allows us to make smarter decisions.

A full transcript follows the video.

This podcast was recorded on Sept. 21, 2016.

Gaby Lapera: We talked a lot about critical thinking without actually ever defining what "critical thinking" is, which is something that, when you think critically, you should always do -- define your terms. So, let's talk a little bit about what critical thinking actually is.

In my view, critical thinking is an active process where you come up with a question, gather information, and then use it to reach a conclusion. What I'm about to say is a definition I got off the internet, but one that I wholly agree with: Critical thinking should be "clear, rational, open-minded, and informed by evidence." This part is my own: Critical thinking is inherently a self-reflective process. I also think, although this isn't mentioned in any of the definitions, critical thinking can be difficult. It can be a difficult thing. And it's something that you have to actively pursue. That's why we decided to do this show today, both to talk about critical thinking in general, and also think how we can use it in our investing lives.

John, let's move on to the next portion of our show: What can critical thinkers do? What would a critical thinker look like to you?

John Maxfield: I would say that you pointed out the key quality of critical thinking, and that is thinking rationally. When you think about thinking rationally, there's so many different elements to that, right? But it is dedicating yourself to following logic, it is dedicating yourself to trying to find -- there's a famous book called The Signal and the Noise, where you have so much information that you have to figure out what to use to make a decision. And so critical thinking is also all about picking the sources, appropriate sources for your information, and fitting them into your rational thought process. That's how I would think of critical thinking -- very similar, probably exactly the same way that you do, Gaby.

Lapera: Yeah. I do have this quote I'm going to read to you guys, it's by a Dr. Paul and Dr. Elder. It says, "Critical thinking is, in short, self-directed, self-disciplined, self-monitored, and self-correcting. It requires rigorous standards of excellence and mindful command of their use. It entails effective communication and problem-solving abilities and a commitment to overcoming our native egocentrism and sociocentrism."

I think the thing -- when I'm unpacking that quote -- that stands out most to me is how many times they say "self." This is because critical thinkers are independent thinkers who do their own analysis. This gets to what you were talking about earlier, with the authority bias. They're not relying on other people to spoon-feed them what they should think.

But the other thing that comes out in this quote is that critical thinkers are people who can admit when they're wrong, and accept information that challenges their worldview. They don't try to massage the sources to try and get everything to support what they already think. They are willing to accept new information and change their minds.

Maxfield: To that point, Gaby, when you're thinking about taking that new information in, you have to not only take the right information and exclude the bad information, but also process it appropriately.

I'm a lawyer -- I don't practice, I write for The Motley Fool. But one of the things that you learn in law school, and one of the things that underlies the legal profession -- which, when you think about what law school is and what law is, it really is just a study of logic, and an application of logic and persuasion and things like that. What it's grounded in is an idea of a hierarchy of precedent. Everything you read doesn't deserve the same amount of authority. In the legal context, the Supreme Court gets more authority than appellate courts, which get more authority than district courts, which get more authority than state courts, and then you have the hierarchy within state courts.

So, it's not only what information you're using, but it's how you organize it and process it that really differentiates somebody like Warren Buffett, who has made massive amounts of money really by just thinking extremely rationally, relative to these investors who have a tendency to underperform the market.