Building An IKEA Portfolio

Cartoon Capers

If you get someone to build an IKEA sideboard – you know, one of those flat-pack conundrums that involves trying to work out what a cartoon character is doing with a hammer, a drill and forty three assorted metal dowels – they immediately place a higher value on it than anyone else would, even if it goes on to develop an alarming 45 degree tilt.  This is the IKEA effect.

It’s associated, sort of, with a more general behavior that’s been known about for years, the endowment effect, in which possession of an item immediately causes us to value it more highly. Just imagine what the impact might be if you build your own portfolio, no matter how wonky it might be.

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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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Behavioral Bias 101: #2 Wishful Thinking

Permanently High

Famously the economist Irving Fisher predicted that stocks had reached a "permanently high plateau", just before the Wall Street Crash. He was talking his own book, having loaded up heavily in stocks. Fisher was engaged in wishful thinking, a cognitive bias that's rife among investors, a notoriously optimistic bunch when it comes to expecting the downright improbable.

Part 2 of 101 Ways To Lose Money

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The Chart Illusion

Timing Dragons

Although, logically, I’ve always felt that the idea of investing by charts should be something on the map between “Dragons” and “Free Lunches” I’ve never been so sure of this as to be outright skeptical. And I know a few smart people who insist that they are at least helpful in timing investing decisions.

Of course, the idea of “timing” anything in investment is fairly ludicrous anyway, but some recent research suggests the whole charting concept does actually help in prediction. Unfortunately what it predicts is a bunch of irrational self-fulfilling behaviour.

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Behavioral Bias 101: #1 Illusory Pattern Recognition

The Man In The Moon

Pareidolia’s that odd moment where you perceive a familiar pattern where none actually exists: it’s the man-in-the-moon, the elephant in the clouds, a religious figure in a pastry. Pareidolia is a specific form of pattern recognition; the human brain is hard-wired to see faces in things, presumably to ensure that babies attend more to other people rather than random bits of plastic.  More generally, though, pattern recognition is critical to human functioning, but has a nasty tendency to go wrong.

Part 1 of 101 Ways To Lose Money

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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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Scamming Journalists with Counterfactuals

Skim and Pump

Every so often there’s a story in the press about contactless payment cards being skimmed and money being extracted from them. Basically someone goes around tapping hapless commuters on the ass with a contactless card reader. Which given the state of the UK’s stupid prosecution service probably puts them more at risk of a charge of sexual assault than being arrested for theft.

This story is a recurring meme, and exemplifies what’s wrong with the state of financial journalism today. And on the way we get to look at real-world conspiracy theories and a bit of behavioral economics. What fun.

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Robobias

Advisors' Suck

There’s a new class of financial intermediary in town: the robo-advisor. As I understand it, the human advisor’s financial knowledge is sucked out of their brains and up-loaded into a machine.  So, that shouldn’t take very long then.

But humans being the clever creatures that we are simply replacing the human advisor with a machine won’t save us from our own stupidity. We’re far too clever for that.

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Investors, Still Chasing Hubcaps

Lowing and Highing

As we saw in The Proper Etiquette for Market Panics – which I wrote the last time we had some major market falls – what usually happens in a crisis is that markets fall and then exhibit volatility, as investors roam backwards and forwards in increasingly large herds while asking everyone else why it's happened and what they should do about it. Often the noise they make sounds suspiciously like cattle lowing.

Well, this happens (the volatility, not the lowing) because going down – and up – is what markets do, and if you don't understand that you shouldn't be allowed to play Monopoly, let alone invest in stocks. And asking what you should do about this after the event betrays a depressing level of incompetence and a woeful grasp of history. On the other hand a bit of cognitive dissonance can be just the trigger to for a teachable moment; the point at which a handful of people actually learn to be proper investors.

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Rethinking Economics: Let’s Get This Schism Started

Doctors of Doctrine

In the wake of the great crash of 2008 a lot of young people suddenly became interested in finance and signed up for university courses to learn about the detail of what went wrong. Instead, what they got was a load of nonsense dressed up as learning that bore little relation to the real world. Well, what did they expect, they chose to study economics?

Our of this was born the Rethinking Economics movement, an attempt to introduce new ideas and concepts into economic education, to adopt a pluralist approach. The problem with this, well meaning though it is, is that reforming economics is akin to Martin Luther nailing his theses to the door of All Saints' Church in Wittenberg: all it does is create a schism in a religious cult. Economics doesn't need re-thinking, it needs to be put out of its misery.

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