Bad Investor Behavior Can Be Very Expensive

Brief interview with yours truly by Robin Powell from The Evidence Based Investor:

Also take a look at SmartInvestorTV for a bunch of other interesting resources.

7 Investing Lessons from Behavioral Psychology

Click … bait

You could start by not wasting your time clicking on stupid clickbait articles, I suppose. But since you’re here you might as well learn something.

Investing should be mainly about hard work, slogging through accounts and trying to figure out where or why a company has a defendable competitive advantage. But that’s not much help if you have the self control of an octogenarian with prostate trouble.  Investing is 90% hard work and 10% mental discipline – but don’t even bother if you haven’t got the 10%.

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Be Humble, Become Wealthy

Thrusting, Decisive and Frequently Wrong

We are both by design and by culture inclined to be anything but humble in our approach to investing. We usually invest on the basis that we're certain that we've picked winners, we sell in the certainty that we can re-invest our capital to make more money elsewhere. We are usually wrong, often extremely wrong.

These tendencies come partially from hard wired biases and partly from emotional responses to the situations we perceive ourselves to be in. But they also arise out of cultural requirements to show ourselves to be decisive and thrusting; we rarely reward those who show caution in the face of uncertainty. But we're private investors, we have limited capital and appetite for risk. A little humility – or even a lot – wouldn't go amiss.

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Bad Behavior: From A to Z … and Back Again

Talking Shop

A common reaction to pointing out to investors (or indeed, anyone) that they're as biased as a Fox reporter at a convention of transgender liberal pacifists is for them to respond, not unreasonably, by asking what they should do about it (that's the investors, not the reporters). It turns out that it's a lot easier to say what's wrong than to actually do anything about it.

The A to Z of Behavioral Bias is an attempt to address that issue, but it does rather show that there's no such thing as a common source of biases; bad behavior comes from many sources and requires many solutions. Or does it?

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Behavioral Resolutions for Behavioral Investors

Death or (um … ) Death

Apparently the ancient Babylonians would, at the start of each year, promise to pay off their debts and return stuff that they’d borrowed, like the lawnmower (or, as we would refer to it, the neighbor’s goat). As we saw in On Incentives, Agency and Aqueducts  they had good reason to be cautious as the punishment for theft was death. Although, to be fair, the punishment for everything in Ancient Babylonia was death. What they lacked in imagination they made up for in consistency.

These days we have less strict incentives to keep to our New Year Resolutions, but would probably find ourselves wealthier if we could stick to a few simple rules. The essence of being a psychologically aware investor is self-control, and what could be less modern and more ancient than that?

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Where Two Strangers Never Meet: Self-Serving Bias

"If you can meet with Triumph and Disaster, and treat those two strangers just the same"

IF … Rudyard Kipling

Problematic Pronouns

We all probably know someone who believes that their successes are entirely down to their own levels of skill and whose failures are someone else’s fault.  To some extent most of us will meet them in the mirror each morning.  This is self-serving bias in action.  As Donelson Forsyth explains it:

“Those told they failed attribute performance to such external factors as bad luck, task difficulty, or the interference of others, and those told they succeeded point to the causal significance of such internal factors as ability and effort.”

Now, what do you think will happen to a corporation if you put someone with a bad case of self-serving bias in charge?  Beware the CEO with a bad case of the personal pronouns, that’s what I say. And let's not talk about global warming.

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On the Invariant Nature of Investor Ineptitude

Behavior is Forever, Not Just For Life

One of our themes here is the unchanging nature of human behavior across time and space.  It doesn’t much matter whether we’re in 1^st century Rome, 17^th century Holland, 18th century Britain or 21^st century America, if you put large groups of people in the same situation they’ll tend to behave the same way when they have money at stake: irrationally.

There’s plenty of evidence from history that this thesis is true, but a recent paper on the seventeenth century’s equivalent of a behavioral finance blogger helps to emphasise the point.  We were irrational then and we’re irrational now, and three hundred plus years of technical advance hasn’t improved this situation one iota.

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Seasonally Affective Investing Disorder

Not Not Die Out

Behavioral bias occurs in all sorts of odd ways, but basically can be traced back through evolutionary history to when humanity’s survival depended on deep co-operation and the invention of sewing.  Our ability to cope with the huge changes in weather conditions experienced over our short history defines our species: we didn’t go extinct.

It shouldn’t therefore be particularly surprising that we’re unconsciously affected by environmental conditions: there was a time, not so long ago, when nothing else mattered.  Now, cosseted by central heating and air conditioning, we’re remote from our material world but, it turns out, for investors our material world is not remote from us.

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A Bias For Real-Estate

Mindblowing Mentality

The evidence for stockmarket investor bias is overwhelming. We are so not rational when it comes to our stocks that the thought that there are still researchers out there trying to develop theories based on the idea that we actually think through what we do is somewhat mindblowing. 

However, you’d expect that if we’re strangely biased when it comes to financial transactions involving the stockmarket that we might also be a bit slanty-brained when it comes to other asset classes as well.  And as real-estate is probably the biggest single investment any of us will ever make it’s probably a prime candidate for a bit of behavioral analysis.

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Regulatory Omniscience is A Fictional Conceit

Who Guards The Guards?

If you’re a regulator you’re likely to be conditioned by motivated reasoning: you should want more stringent regulation because, after all, that’s what you get paid to do.  You’ll base the need for more rules on reasoned analysis, but your analysis will be directed by your incentives.

Regulators are human; ergo, they’re subject to behavioural bias. Quis custodiet ipsos custodes?

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Investor Decisions – Experience I­­s Still Not Enough (But It Helps A Bit)

Weaselly Satisified

The idea that personal experience isn’t enough to help investors make better decisions is one we’ve investigated before; particularly in Investors Decisions - Experience Is Not Enough.  The general idea is that our personal observations don’t generalize, because market behavior is continually adapting under evolutionary pressure.

Now recent research confirms this, up to a point.  Which is a weasel-worded way of trying to convey the idea that I wasn’t exactly right but don’t want to admit it.  Before we get all excited, however, the general idea still applies: experience helps, but only up to a point.  And the point is very, very sharp and very, very expensive.

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