The Wrong Way To Use An Index Tracker

Sedate and Inept

Index tracking is supposed to be a sedate affair, a quiet contemplation of the tempestuous dynamics of market forces from an appropriate distance.  A passive approach to investing, if you will.

Instead it seems that people who use index trackers either don’t understand that they’re simple commodities or simply trade them like any other instrument available to private investors: frequently, ineptly and in a manner calculated to abrogate their inbuilt advantages.  Nothing new there, then.

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Dirty Money: There IS Accounting For Taste

Unfungible People

The link between emotions and decision making, particularly financial decision making, has been recognized for years.  This is a tricky area because the connection between emotions and rationality is difficult to unpick, which is why making investment decisions while in an emotional state is usually not recommended.

To complicate matters, though, it now appears that we associate certain types of money with certain types of emotion, and will only spend such money on certain things.  Which is odd, because the last time I looked money doesn’t seem to be especially emotional: it rarely breaks down and starts sobbing when you try and spend it.  Money is fungible, but people aren’t.

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Happy People Make Terrible Traders

Optimistic Fools

People who are happy are more confident and expect to make more money by trading, and anticipate taking lower risks in doing so. This result ought to be enough to depress most people, but most people are optimistic and don’t depress easily. This is especially true if they make money on their random trades, because that makes them happier, more optimistic and more prone to trading.

Even better, over-optimistic people are more socially popular and therefore more likely to be imitated. Whether any of this will really make anyone happier is doubtful, but we can but hope. It certainly won’t make for better investors.

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Parsimonious, Big Picture Behavioral Bias

107 Ways of Being Wrong

As we’ve seen in The Big List of Behavioral Biases, there are 101 (well, 107 at the time of writing) ways in which people exhibit irrational biases. The basic idea, that we’re affected by these biases in predictable ways, is now well accepted. The problem is that there are simply too many biases for this to be the be-all and end-all of the explanation of market irrationality.

So while the basic concepts of behavioral finance are understood, in the sense that irrationality is a driving force of market misbehavior, the underlying mechanisms by which they operate are not.  There's not much point in claiming that these behaviors are predictable if you can't use them to predict anything, So what's the big picture of behavioral bias: how does it all fit together?

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Become A Safer Investor – Get Married

Sex and CEOs

Sexual selection – the competition for mates – lies at the heart of Charles Darwin’s theory of natural selection. All things being equal – which they never are, of course – any behavior or attribute which makes an individual more attractive to breeding partners should end up being selected for because the unsuccessful individuals in the mating game leave no offspring.

Given the biological imperative to pass on their genes you’d expect people to fairly aggressive in trying to do so. The evidence suggests that humans, like other species, tend to become risk-takers when confronted with the need to acquire a partner, particularly one of higher status. All of which leads to the slightly odd conclusion that, if you want your money handled as safely as possible, you should look for married managers in stable relationships. Or women.

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Greece, Catharsis and the ECB Moneylenders

Viciously Circular

In the depths of the Great Depression US unemployment hovered around the 25% mark, with 30% of the youth unemployed.  Today in Greece the comparable numbers are 22% and a scarcely believable 54% (see: Greek Labour Force Study). Meanwhile another €4.2 billion has been pumped into Greece by the European Central Bank (ECB) via the European Financial Stability Facility, despite the vast protest vote against the externally imposed austerity measures delivered in their recent elections.  

Unfortunately this money isn't being used to reflate the economy and maintain the social fabric of the county,  it's actually allocated to a “segregated debt service account” which, in effect, is used to repay the debt that the Greeks owe to … the European Central Bank.  It’s little wonder that voters have exhibited a longing for catharsis: emotional cleansing awaits.

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Is Your CEO A Psychopath?

“She was interviewing a psychopath.  She showed him a picture of a frightened face and asked him to identify the emotions.  He said he didn’t know what the emotion was but it was the face people pulled just before he killed them.”

(The Psychopath Test, Jon Ronson)

A Boardroom Blitz

Psychopaths lack empathy, are pathological liars, have an enormous sense of self-worth, are impulsive, irresponsible and won’t accept responsibility for their own actions.  They make up 1% of the total population, 25% of the criminal population and, by some accounts, 4% of corporate boardrooms.

Of course, someone who believes that the only role of business is to maximise profits, regardless of the human cost, is only following the mantra of standard economic theory.  On the other hand, an academic discipline that provides covert justification for a behavior pattern that would get you locked up outside corporate HQs may just have reached the end of its natural lifespan.

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Angels, Pinheads, Capital Gains and Dividends

A Middle Aged Dispute

Medieval scholars have a reputation for disputation on the most abstract and rarefied of theological questions, the “how many angels can dance of the head of a pin” problem.  Of course, this is now a byword for particularly pointless, time-wasting debates.

Modern investors have their own equivalent conundrums, such as “does market growth come from dividends or capital growth?”  Just like its Middle Ages counterparts it turns out that the answer is neither obvious nor unimportant. 

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Mindless With Money

Non-conscious Numbskulls

We all know the feeling of mindlessness. You get it when you drive the same roads as usual and get out at the end not remembering anything about the journey, or when you eat a meal without tasting it, or leave a meeting without the faintest idea what just happened. Yet to everyone around us we’ve behaved just the same way we always do.

There’s something really odd about this, because it suggests that we don’t need to be conscious of what we’re doing to achieve what we want to do. Whether that’s a good thing or not is debateable, because being mindless with money is likely to cause results that might be best described as “unfortunate”.

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