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Tuesday, 3 March 2015

I Don't Know What I Like (And I Don't Know What It's Worth, Either)

Axiomatic

One of the fundamental axioms of economics is that we know what we like: we have preferences, they're consistent across time and they can be revealed by careful experimentation. This, of course, is utter nonsense. Yet it's not just a guiding principle of economics but is also a rough and ready rule we live our lives by. We make decisions and then we justify them, after the event, because to do otherwise would make a mockery of our choices.

But because we do actually make decisions we must, in a sense, really know what we like, even if we're habitually inconsistent. Unfortunately, outside of our own specialised areas of expertise we don't know how to absolutely value things and all too often we assign a value based on entirely superfluous data intermingled with a bit of relative valuation, reckoning that a Porsche 911 Carrera is worth more than a child's teddy bear. We exhibit coherence but in an arbitrary fashion - a behavior known, rather unoriginally, as coherent arbitrariness.

Wednesday, 25 February 2015

Novelty, Unicorns and the Stressed Investor

Bad Hair Days

There’s a Groundhog Day effect in financial markets: wait long enough and another crisis will occur and everyone will be stunned and surprised. In fact they’ll be just as stunned and surprised as they were the last time one occurred. We’ve the attention span of a distracted goldfish when it comes to noticing the disconcerting regularity of market mishaps.

But although market upheavals are frequent they’re not so frequent that we get used to them. The steady state is a constant background hum of noise punctuated by occasional bouts of excitement over some stock or other. When a crisis occurs it’s a novelty – and for most of us our response to novelty is to get stressed, and then run around like our hair is on fire. By and large, I'd observe, this is not optimal investing behavior.

Thursday, 5 February 2015

Beyond the Dismal Science

The Passionate Science

Back in the nineteenth century Thomas Carlyle described economics as “the dismal science”, a term that’s been wheeled out ever since whenever some hackneyed journalist or febrile blogger feels the need to criticise something to do with money. It’s a snappy little phrase, and is all too often justified.

Well, now a couple of behavioral economists have written a book that attempts to refute that label. In the words of John List and Uri Gneezy in The Why Axis: Hidden Motives and the Undiscovered Economics of Everyday Life economics is a passionate science – one that is:
“Fully engaged with the entire spectrum of the human emotions … and with the capacity to produce results that can change society for the better”.
So if you want to know how to price wine correctly, or to improve the performance of students or get people to donate more money to charity or level the playing field for women at work then this is the place to start. And if you want a tool kit to improve your performance at, say, investing, then you’re in the right place.

Thursday, 1 January 2015

Investing In Our Children

Live Long and Prosper

Statistically, a child born today is more likely to reach 100 than someone who is already 96 years old. And this is happening at a time when government resources are increasingly stretched and retirement ages are creeping upwards, when the populations of the developed nations are aging and the borders are increasingly closed to younger people from poorer countries.

As parents the one thing we can do for our children, to prepare them for this dystopian future, is give them the skills they need to survive and, hopefully, prosper. And chief of those skills, in a world dominated by the ideology we call capitalism, is a proper understanding of how to manage money: because the alternative is that money will manage them.

Friday, 19 December 2014

Saving the Appearances (of Standard Finance)

Unbalanced

Back in the Europe of the Middle Ages there existed a curiously schizophrenic attitude to the question of whether the Earth was at the center of the universe. The doctrine of the established Catholic Church decreed that it was. The practical evidence suggested that it wasn't and the orthodox scientific theory endeavored to fit the evidence to the theory, at the expense of commonsense and logic.

Today there exists a similarly curious attitude to the question of whether or not economics is governed by people making rational decisions in consistent ways. The doctrine of the established economic theory says that it is. The practical evidence suggest that it isn't. And the orthodox economic theories endeavor to fit the evidence to the theory, at the expense of commonsense and logic.

Monday, 27 October 2014

Quality Plays

Rational Exuberance?

One of the odder financial bubbles we saw in the last century was caused by a bout of temporary insanity in the 1970's over a group of the biggest and best American corporations. The so-called Nifty Fifty were, for a while, promoted as the must have, long term buy and hold stocks. And with a certain pleasing inevitability the stocks soared and then, in strict adherence to the law of financial gravity (and very grave it is, too), plummeted. Another mental meme dashed against the rugged rocks of reality.

Only this story isn’t so simple, because the Nifty Fifty weren’t a bunch of story stocks flung high by the whim of investors’ irrational exuberance. They didn’t just disappear having made their owners very rich and their shareholders poorer, and no wiser. The afterlife of the Nifty Fifty tells us an interesting story about the nature and durability of quality in the stockmarket: quality plays, if you understand the rules of the game.

Friday, 17 October 2014

Facing Down The Narrative Fallacy

Frenzy Time

Markets are tumbling. It's because the Fed is about to push up interest rates. Or maybe because the German economy is weak. Or perhaps it's Ebola, about to decimate global populations. Or it's geopolitical conflict - Ukraine, Syria, Iraq ... take your pick. It's a perfect storm. Head for the hills and don't spare the horses. And remember the shotgun.

Of course, it's none of these. Markets are falling because they were a bit overpriced and investors were ignoring the fact because they'd got themselves into a typical feeding frenzy, ignoring the risk and ambiguity that are always present. Now that they have recognized the issue they're fighting each other to get out the door. Which is why all of the explanations for market weakness are entirely plausible and entirely wrong - they're an example of what Nassim Taleb calls "the narrative fallacy".

Wednesday, 10 September 2014

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.

Monday, 4 August 2014

Metaphors We Invest By

Lost for Words

Metaphor is a powerful engine for driving thought. Or possibly it's a useful compass for guiding it. Or perhaps it's some other metaphor. The point is the we tend to think in metaphors, even about metaphor, and it seems that the metaphors we use to describe a situation  determine how we view it and what we do about it.

So companies may be in a tail-spin, or simply marking time. Or perhaps they're in terminal decline, or maybe it's merely a temporary setback. And maybe we're talking about the same thing, and how you hear it described determines your reactions to it ... metaphor is powerful, acts on us unconsciously and is almost completely useless to an intelligent investor.

Monday, 28 July 2014

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?