Why There’s Never Been A More Dangerous Time To Invest

Facing the Big Guns

Tadas Viskanta, who writes and curates the excellent Abnormal Returns, recently penned an equally excellent article entitled There Has Never Been A Better Time To Be An Individual Investor. In this he cogently sets out a list of reasons why investing is cheaper and easier than ever before while caveating that our innate biases work against us when investing.

While agreeing with every word of the article, I think there’s danger for anyone executing anything other than the suggested default option of a low cost, globally diversified, occasionally rebalanced portfolio. Active private investors are engaged in an arm’s race with the securities industry and most of the big guns are facing the wrong way. The problem is that darned scientific method, which is why there's also never been a more dangerous time to invest.

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The Curse Of Seven

I’d like you to memorise a number for me. The number is 111011101001101010010. Easy, huh? Now, read on.

Shouting at the Plastic

We humans have many unusual traits. We’re the only mammal that can’t swim when it's born, the only mammal whose male can’t tell when its female is fertile, we have large brains which we habitually attack with fermented grains, we walk upright other than in ongoing fermented grain situations, and, perhaps most importantly, we use language to communicate (even when fermented grains are involved).

Now language, of course, is a curious thing. Given the huge amount of brain space and energy it consumes it was clearly very important to our survival as a species. So it’s odd that many of us then use this gift to shout inanely at mobile phones in public spaces. That’s what we call an “unintended consequence” and it helps lead to a big investing problem, the issue of information overload.

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Have You Been Nudged Today?

Quills and Nudges

The British Civil Service is not a body known for radical change; it’s never quite got over having to give up the quill pen and tends to view with suspicion newfangled ideas like computers and women in the workplace. Despite this it’s currently at the heart of a large scale experiment on the use of techniques from behavioral science, aka, “nudge” theory.

Sitting at the center of UK government is the Behavioural Insights Team (BIT), which is tasked with using behavioral approaches “as an alternative or complement to regulation or bans”, while achieving a ten-fold return on the cost of the team. They’ve just released the results of their first set of trials on fraud, error and debt, and these suggest they’re likely to continue, as the potential savings look like they’ll be quite significant. Wherever you are, you can expect to be nudged, prodded and cajoled into being a better person; or at least one that pays their taxes and turns up to doctors' appointments on time.

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Trimmed by the Hedge Funds

Secrecy and Suspicion

The increasing importance of hedge funds in the market has attracted attention, especially since they've become every politicians' favorite target when discussions move to market stability and manipulation. The secrecy associated with their activities arouses both mystique and suspicion.

New research suggests that this secrecy is important to hedge fund outperformance and, counterintuitively, argues that the attempts to maintain that secrecy are partially responsible for the outperformance. It also does nothing to quench the concerns that covert manipulation by fund managers is occurring, at the cost of obscuring real market signals. So, are we being trimmed by the hedgies?

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Backfiring Investment Theories

Holy Theory

We’ve met the nasty nature of confirmation bias on several occasions. This is the twisted trait that sees us in thrall to the views of others around us, and helps us encourage them to maintain those views, regardless of anything resembling reality. But this is only the half of it.

No, we also have to cope with the impact of information that blows huge great holes in our world views and which undermines our most devoutly held beliefs. When faced with unequivocal evidence that shows that our favourite investment ideas are wrong we do what you really ought to expect by now: we don’t so much ignore it as twist it to our own predetermined ends. Folks, meet the wonderfully counter-intuitive backfire effect.

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What’s YOUR Competitive Advantage?

The Zanzibar Effect

Everywhere you look in the investment industry it appears that the odds are stacked against the smaller investor. In every trade we make there’s a counterparty against whom we’re taking a bet and all too often they’re better informed and equipped than we are. For the most part trading is simply a way of enhancing the profits of the securities industry.

As any investor knows, the key to a successful business is establishing a competitive advantage, so it makes it all the odder that most traders seem determined to compete head on with institutions in exactly the areas they want us to. There’s no rational explanation for this other than people are blind to the ways in which they’re being exploited. In terms of competitive advantage private investors engaging in short-term trading against financial institutions is the greatest mismatch since the Anglo-Zanzibar War of 1896 which lasted only 45 minutes - and which ended with the British being paid for the shells they’d fired into their opponent’s country.

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