Less Is More

Error, Human

Much market analysis operates on the assumption that more data is better – more data leads to more accurate results. More data may require more complex processing, leading to greater and greater requirements for computing power but, in principle, the idea is that more is better.

Out in the real world, however, we don’t have the luxury of this kind of analysis. This leads to errors which sometimes we call biases. But surprisingly it also, often, leads to better results. It may just be that the reason we make so many mistakes is because we’re trying to process too much information, not because we’re naturally error prone.

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Five Commandments for Investors (Or Why Dogs Can’t Catch Frisbees)

Dogs and Complexity 

One of the more thoughtful regulators around is Andrew Haldane of the Bank of England whose speech “The Dog and the Frisbee” from 2012 remains the touchstone for anyone wanting to appreciate the reasons that modern economics has made a mess out of understanding the real world.  To boil the whole thing down to a single statement: you can’t control a complex system with complex rules, complex systems require simple rules.

Applied to regulation this is revolutionary, applied to investing it adds to reams of evidence suggesting that most investors need to avoid overcomplicating their analyses, that simple rules of thumb outperform detailed analysis and that mostly we’d be better off going off to the beach with a Frisbee rather than pouring over the latest numbers. It’s all guesswork anyway, best take the easy option.

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The Turkey Illusion: An Audience With Gerd Gigerenzer

Thanksgiving Comes

Imagine you’re a turkey. Every day you're approached by a man with a bucket of corn who feeds you.  What kind of mental model of what happens when he appears do you think you’ll build up?

Gerd Gigerenzer, the Director of the Max Plank Institute for Human Development and the Harding Center for Risk Literacy uses this story to demonstrate the financial industry’s approach to modelling decision making under uncertainty.  We pay rich financial services organizations to make predictions based on the past that are only ever correct by chance, in order to absolve ourselves of responsibility for when they go wrong.  It’s a waste of time, money and talent.  Because, of course, Thanksgiving always comes.

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Robert Cialdini and the Weapons of Influence

“Well here, again, Cialdini does a magnificent job at this, and you’re all going to be given a copy of Cialdini’s book. And if you have half as much sense as I think you do, you will immediately order copies for all of your children and several of your friends. You will never make a better investment.”; Charlie Munger on The Psychology of Human Misjudgement.

A World Too Complex

One of the recurring themes in behavioral economics is the concept of bounded rationality: the idea that we’re perfectly rational up to the point at which our limited brainpower stops out. Cialdini’s Influence turns this idea on its head, and argues that it’s our brainpower that’s created a world that’s too complex for us to understand: and that the result of this is that we take mental shortcuts, which then open us up to exploitation at the hands of any unscrupulous third-party. Which is pretty much everyone, these days.

We'd argue that these weaknesses are exposed directly in stockmarket investing when we're not so much fooled by other people as dumbfounded by our own brains.  Influence is not about investing, but about psychology: which makes it essential reading for everyone, but especially investors.

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Investing at the Edge of Reality

Relief from the Bizarre

Mostly we expect scientists to make the world a more understandable place – or at least a more comfortable one. After all, science has helped us move from a state in which we prayed to invisible deities for deliverance from natural disasters to one in which we rely on functionally illiterate politicians to direct relief operations. So, perhaps prayer isn’t entirely irrational…

Unfortunately, as we’ve dug deeper into the mysteries of the multiverse, increasingly we’ve been forced to face the fact that reality is more bizarre than we can possibly imagine and that our senses offer us only a limited window on the world. Oddly, though, it also hints as to why we make investing mistakes.

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