Notes for entrepreneurial investors
Posted on October 1, 2007 by Richard Beddard
Filed Under Investing |
Repeat after me: We’re not stupid. We don’t have to act like cavemen.
Joe Nocera, a journalist, says small investors are hapless:
Small investors spend hours on chat boards, where the herd mentality is fiercest. They can’t bring themselves to sell losing positions, even when the stock is still going down. They bet everything on one or two high-risk stocks. I do not exempt myself from this behavior: a decade after the Crash of ’87, I was loading up on tech stocks during the Internet bubble, even as I was writing article after article about how the bubble couldn’t possibly last.
Roger Ehrenberg, a blogger and angel investor, laps it up. He quotes large wodges of Mr Nocera’s article, adding observations of his own.
A book sparked off this round of investor bashing. Mr Nocera reviewed the book, and Mr Ehrenberg reviewed the review. The book is Jason Zweig’s “Your Money & Your Brain.” Mr Zweig is a good investment writer, and I haven’t read the book, so I’ll not judge it.
But what ticks me off about the commentary is the hackneyed belief, as Mr Nocera puts it, that:
…most human beings are simply not hard-wired to be good investors.
That observation is usually followed by an explanation of how our caveman-like brains are hard-wired to bolt at the first sign of danger, which explains why we sell when everyone around us is selling, and buy when everyone around us is buying.*1
Why on earth would we be hard-wired investors? I’m no geneticist, but the story of human evolution is a relatively long one, and the history of stock markets a relatively short one, so it’s unlikely the current generation of investors would have evolved super-brains, perfectly attuned to the way of the market.
What makes me really clench my jaw though, when I read it, is the conclusion that our money’s not safe in our own hands. Or in Mr Nocera’s words:
Despite everything, Mr. Zweig remains an investing optimist. He still thinks that people can learn to resist their emotions, buy those low-cost index funds, step away from the herd and all the rest of it…
I came away from Mr. Zweig’s book feeling just the opposite, though: that there is really not much hope that we’re ever going to get the hang of investing.
Come on! My first experience with a bike was falling off. We’re not hard-wired to ride a bike. But we wouldn’t let that stop us learning. Saying we’re not hard-wired is merely another way of saying we’re not trained, or not educated.
By definition most investors follow the herd. But there are plenty of investors who will find Mr Nocera’s characterisation sweeping and patronising. They know what they’re doing, but we hear less from them because, unless they’re Warren Buffett, the herd is more newsworthy.
If we’re not prepared to learn, we’ll probably loose money. But that’s a long way from saying there’s no hope we’ll ever get the hang of investing. If we’d applied the “no hope” doctrine to other walks of life, we’d probably still be cavemen.
Footnotes:
- I suspect the emerging field of behavioural finance is less trite than that, and it’s probably presented simplistically in the media. Another writer applying psychology to the markets is blogger James Montier, whose new book is “Behavioural Investing“. Judging by his blog, it ought to more insightful. Ken Fisher’s The Only Three Questions That Count buys the caveman line, but in demonstrating scientific investment strategies that work, also shows us how we can overcome it.
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3 Responses to “Notes for entrepreneurial investors”
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This sounds familiar Richard…
There are a lot of us pessimists around.
As for behavioural finance, yes there is a lot more to it than the idea that investors have heard instinct, however very little of it is encouraging.
Even given your more optimistic stance on the chances of out-performing, it is very important that this issue is raised. Investors MUST strive to be detached and resist herd instinct, and they must make sure they understand everything they invest in.
Hi Graeme,
It does, and I realised while I was writing this rant that I was teetering towards reopening the whole efficient market debate. At some point I won’t be able to stop myself
I agree entirely with your last paragraph, of course. In a sense, it’s the essence of investment.
Wish you a happy Halloween. On this special festive occasion we are conducting a giveaway of Zweig’s book which you have profiled in your post.
Enjoy and Good Luck!