Entries Tagged 'Behavioural Finance' ↓

Most Friday’s I drop my daughter at dance class, head to one of Melbourne’s best cafés and have a latte while I wait for Borders to open at 10. I then have around 20 minutes to choose and scan an investment book. While I am normally a slow reader I can skim a book in 20 minutes and pick out a few lessons which resonate with me.

Today my book of choose was Way of the Turtle, by one of the original turtles, Curtis Faith.

Almost every page I scanned contained a gem. From the introduction where Faith said he has learnt something from almost everyone he has every interacted with to his thoughts on edge and his simple clear rules. Continue reading →

Belief Systems

Why do so many intelligent people not transfer their success to investing success? Think about that for a minute. Got an answer?

Now consider this question. Why has investing research such as the following found that psychologists are more successful investors than some of the smartest people around?

Recently, a research, which was conducted by Bank of England, the universities of Heidelberg and Bonn together with McKinsey, observed the share-buying behavior of about 6,500 persons in an Internet experiment. They found that psychologists, particularly, were good at guessing other players behavior and mistrusted the overvalued stock by others. On average, psychologists were markedly more successful in their speculation than physicists or mathematicians - or even economists.

One answer is that most investors focus on valuation and detailed fundamental research as their belief system tells them a scientific, quantifiable, repeatable approach is the path to success. After investing for twenty years I am almost positive (that’s as sure as a doubter like me gets) that there is no edge to be gained from valuation and detailed fundamental research. Perhaps the absolutely smartest, most experienced and skilled fundamental investor can gain an edge through their research, but is that you? Fundamental analysis is a necessary step, for most investors, but it is not the key to alpha.

Take a few minutes to consider what beliefs you may have that are stopping you from become a better investor. Invert every belief you have. Consider your core investing beliefs from every angle.

A life coaches would suggest you make a list of all your disempowering beliefs and ask yourself these three questions:

1. Why do I believe this?
2. What is this belief costing me?
3. What do I have to loose if I let go of this belief?

I hope you found at least one investing belief that limits your possible success. I’d love you to read what it was.

Didn’t come up with a disempowering or limiting belief?

How about these few?

• It is impossible to time the market. (Any belief you have which includes the word impossible should receive double your focus!)
  Invert it.
  It is possible to time the market. Now write down, research, consider how it is possible.
• Technical Analysis is a waste of time.
  Turn that frown upside down.
  Technical Analysis can give me an edge and help me gain an extra percent or two when both buying and selling.
• Options are risky?
  Options are less risky than direct share ownership.

A major disempowering belief that I have held since my early teens is that I could never be a teacher. When I became a dad I realised that was a disempowering belief I had to tackle head. I’m still working on it and hopefully incrementally improving. Part of my problem is another disempowering belief I’ve held since childhood, I must learn that not everyone is a dickhead!

So why do psychologists outperform? They understand behaviour and have learned understanding of psychological biases. Could that become an edge for you?

Cheers
Dean

One of my favourite investing topics is behavioural finance. It is the area which I believe has the largest effect on the returns of most investors. I consider getting to know yourself a very valuable endeavour and should be a priority for all investors. Many investing newsletter writers and analysts have already mastered stock picking and will sell you their ideas for a relatively inexpensive price. The place most investor can add real value to their portfolio is in understanding themselves and conquering their biases. But then again I would say that as my first degree many moons ago was in psychology, so I probably have a psychology bias.

Cognitive Biases
When does the virtue of patience become the failing of commitment bias? I believe it was Whitney Tilson who said that when you change your investment thesis to remain invested in a company then you have commitment bias. If your original investment thesis has not worked out then it is time to sell, if you find other reasons to hold then maybe you have commitment bias.

Here is an archive of Whitney Tilson’s posts on the Motley Fool. Others may be found here at Tilson Funds.

List of cognitive biases from Wikipedia.

And some more biases

Investor Psychology

• Here is one of the many articles Tilson has written on investor psychology.
  And another one I can’t find a “Putting Someone on a Pedestal” bias, but I am sure it should be there somewhere as it is surely one of the biggest biases in investing
• Cognitive Dissonance. This NY Times article on the Monty Hall Problem has some great insights into cognitive dissonance.
• What is Behavioral Finance? An interview with Meir Statman.
  Another interesting paper by Statman is this on the rules of diversification in behavioral portfolio theory. I don’t agree with many of the ideas put forward, but nonetheless the paper is worth reading.
• So You Want To Be The Next Warren Buffett? How’s Your Writing? By Mark Sellers
  This speech that Sellers gave to a Harvard MBA class is a must read for all investors. It resonated strongly with me as I have always believed it is ones psychological make-up that is the largest factor in your investing success. Read this to realise that 20% annual compounded gains is a delusional aspiration for most people. Investing is not a get rich quick scheme it is a life passion and even then you’ll be doing well to beat the indexes my a few percentage points.
  I always found Sellers discussion on psychology the most interesting part, though he also provides interesting insights into economic moats and prompts the reader to consider their own investing moat.
  I believe his speech would have been more useful if he provided some tools to improve the traits which he mentioned, but he seems to be of the opinion that they are hardwired and can’t be overcome.

  Sellers seven traits are:
  1. Ability to buy fear sell greed.
  2. Obsessive about investing.
  3. Willingness to learn from past mistakes.
  4. Inherent sense of risk based on common sense.
  5. Confidence in convictions.
  6. Both sides of your brain working.
  7. Remain true and thoughtful in a volatile environment.

  My favourite psychology professor devoted a lecture to ways to improve the connection between your brain’s hemispheres. I’m sure Google can provide some good ideas. My favourite has always been juggling. It is one of the few activities that simultaneously engages both hemispheres and strengthens the link between the two. I recommend you add juggling to your daily routine, if you don’t already do it. For parents out there, kids love it and it fun for all the family.

  A quick primer on the brains hemispheres.

• Inertia and indecision.
  From the MMC March 2008 Update.
  In the recent edition of the Outstanding Investors Digest, a highly regarded US value manager Seth Klarman from the Baupost Group neatly summed up the impact of fear on an investor:”If a loss freezes you from taking full advantage of a great opportunity, or pressures you to make it a smaller position than it should or would otherwise be, then the cost of a loss may be far greater than the initial loss itself.”

Thanks for reading and feel free to leave me a comment

Dean Morel