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Wednesday 1 September 2010

A Keynesian Theory of Mind

The Mental Cell of Autism

Autism is one the crueller tricks that nature plays on human beings, leaving sufferers isolated, incapable of making social connections and effectively trapped within their own heads. Although the causes aren’t fully understood some of the consequences are, and chief among these is the inability of sufferers to take on the perspective of others. This failure to develop a so-called theory of mind means they simply can’t understand the needs and motivations of other people.

According to John Maynard Keynes a proper theory of mind is just what an investor needs to keep one step ahead of the crowd, although others feel that Keynes’ approach to investing is tantamount to chasing returns all the way to poverty. It raises the question, though, as to how much a person’s genetic makeup determines the type of investor they are. Are effective value investors really just socially inept wallflowers or simply extremely focused individuals?

A Theory of Mind

It’s become clear that autism isn’t a straightforward condition. Although extreme autism is utterly disabling and sufferers can’t live a normal life or even look after themselves there is a spectrum along which we’re all spread out. Improved diagnosis methods have shown that many people have mild forms of the problem, usually referenced as Asperger’s syndrome. Such people prefer to be solitary and are generally fairly rubbish socially.

To explain this the concept of “theory of mind” has been developed by Simon Baron-Cohen who describes it as:
“… being able to infer the full range of mental states (beliefs, desires, intentions, imaginations, emotions, etc) that cause action. In brief, having a theory of mind is to be able to reflect on the contents of one’s own and other’s minds”.
In short, it’s the ability to mind read, which the majority of us can do effortlessly without even realising we’re doing it. We're able to take on the place of another person, to imagine what they’re thinking and then to respond on that basis. It’s the foundation of social interaction and when a person can’t do this, when they’re autistic, they’re locked in their own skull, unable to get out. A simple diagnostic test is to yawn: many readers will yawn in sympathy with the word let alone the action. Around half of us will yawn when someone else does, someone with autism won’t, ever.

Generally speaking people who suffer from autism are pretty much at the mercy of the world, but further along the spectrum Asperger’s syndrome allows for a wide range of behaviour. Usually it’s associated with poor non-verbal communication, a lack of empathy with other people and bad coordination. Of course, those symptoms apply to most men when drunk, but Aspbergers is a broad church and the range of effect is very wide. Most notably, though, they have problems with social interaction: in short, they have a poor theory of mind.

A Keynesian Theory of Mind

All of which is very interesting but what, you may be wondering, does it have to do with investing? Well, potentially rather more than you might think. Back in the 1930’s the economist John Maynard Keynes, in The General Theory of Employment, Interest and Money described an investing approach using the idea of a newspaper beauty contest to get his ideas across:
“.. professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one's judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be.”
And if that isn’t a use of theory of mind I’m an orang-utan. Ook.

Value Investing Can’t Work

Keynes’ point was that a successful investor needed to anticipate what other investors were going to be interested in. He went further, however, and produced a powerful argument against value investing – on the grounds that while it might be theoretically a nice idea in practice it wasn’t practicable. Investment based on fundamentals was, in Keynes’ view, impossible because individual human psychology simply didn’t permit it to succeed. In his view ‘enterprise’ – his term for rational investment on a long term basis:
"...only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come. Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die;—though fears of loss may have a basis no more reasonable than hopes of profit had before".
Or, in other words, even value investors rely on a fine judgement about what people will want in the future, rather than a rational analysis of long-term income. A Keynesian theory of mind for investors implies that they need to spend more time thinking about what others will want than the underlying economics of any given investment.

From Keynes to Graham

Yet we know, to a reasonable degree of certainty, that there are investors who are able to make a very decent, long-term turn on the markets by dint of ‘enterprise’ alone: the so-called Superinvestors of Graham and Doddsville. So was Keynes simply wrong?

Well, likely not. Keynes put his finger squarely on the motivation of most investors who, for our sins, are created with a full theory of mind and are unwilling and unable to ignore their beliefs about what other people will want when they invest. Mostly they’re wrong, but turning off the switch that makes us human is an incredibly hard thing to do.

Yet there are people who can succeed in this. Warren Buffett has suggested that the most important attribute for an investor is “focus” which is possibly simply another way of saying that it’s important to ignore what other people think and to follow your own beliefs. Of course, your own beliefs need to be informed by analysis and infused with intelligence, but quite how you can both do that and function normally in polite society is beyond me.

A New Theory of Mind

One obvious answer – that the great value investors are, in fact, suffering from a mild form of Asperger’s – is certainly possible. Yet many of these people are amongst the best communicators of investment ideas and philosophies there are. However, what they tell us is that our innate theory of mind leads us astray in investment matters and to succeed we need to stop believing we can anticipate what other people will do: a position Keynes regarded as impossible.

Since “believing we can anticipate what other people will do” is practically a definition of the human condition this is easier said than done. Buffett himself has remarked that people who “get” value investing do so almost immediately and those that don’t never do. So perhaps being a good value investor isn’t something you can learn, because perhaps most of us can’t switch off our theory of mind at will. It would be an irony, really, if most of us can’t be good investors because most of us can’t help but think like humans. Still, far better that than the terrible alternative.

Related articles: Laplace's Hammer: The End of Economics, Ambiguity Aversion: Investing Under Conditions of Uncertainty, Metaphors of Mind and Money


  1. I think Keynes is talking about entrepreneurs rather than value investors. Enterprise wouldn't die if value investors stopped hoovering up shares in cheap companies, but it would if entrepreneurs were as risk averse as value investors.

    Value investing is a lonely and self reliant activity. But I reckon it's possible to restrict your focus in terms of investing and still be outgoing in other areas of life. Hence Graham, Buffett et al. were/are educators as well as investors and sought/seek a public profile. Michael Burry, who famously invented the Big Short on CDSs, has Aspergers, but I don't think it's necessary!

  2. Actually Keynes didn't "propose" the beauty contest as an investment approach. He was describing how investors act. He was actually saying that this behavior is what is wrong with investment markets - investors do not look at the long run in making decisions.
    It was part of the reason he believed that government should be more involved with investment - something that is on the front burner today. Many economists believe that China's type of capitalism where explicit government incentives channel investment into areas productive in the long run for their economy is one reason for the continued strong growth.

  3. turning off the switch that makes us human is an incredibly hard thing to do.

    Not necessarily.

    How do free markets work? Each person makes choices that benefit the entire society, thereby creating an Invisible Hand that causes companies that do a poor job to fail and companies that do a good job to succeed.

    How did we get everyone to help out in this way? By appealing to their self-interest! People are incredibly responsive when you show them what is in it for them.

    So it is with investing. Show people how much sooner they can retire if they give up Buy-and-Hold investing strategies, and you get their attention. There is no one alive who does not at some level of consciousness want to become a better investor.

    This has never been tried. Not in a big way. There are niche sites where people talk about the realities. But we have never made it a society-wide thing. I am confident that, when we do, we will see that people will once again act in their own self-interest (and thereby make the entire society far richer than what it could ever have become in the Buy-and-Hold Era).


  4. I think that DIY is right to say you have misread Keynes, who was himself arguably the most successful value investor in history, one whom Buffet studied and emulated.

  5. "Of course, your own beliefs need to be informed by analysis and infused with intelligence, but quite how you can both do that and function normally in polite society is beyond me." Really ? How sad. Me, I sometimes use a little thing called Tact.

    Seriously, if you'd have included the truly hard part in value investing - expressing your opinion, and sticking to it despite the day-to-day market ruckus, the unhappy statement I chose to call out would be harder to disagree with. Value investment makes stop-loss implementation problematic.

  6. Michael Burry is an example of someone with Aspergers who has been wildly successful as a value investor. In fact, you can make the case that his Aspergers has been one of the main factors behind his success. How? For starters, it allows him to ignore the crowd, form his own opinions, and swim against the tide, which is crucial for any value investor. (This is a way in which poor theory of mind is helpful, not damaging). He was one of just a handful of managers who saw the housing bust coming and had the stones to bet big against it.

  7. I think it’s possible to make a case that Keynes was arguing against value investing even while practicing it: the man was a mass of contradictions. But really the article's about Theory of Mind as applied to investing, not Keynesianism or Keynes' own investing approach: I was using Keynes's description of the mental processes behind speculation to segue from psychology to investing.

    However, the trajectory of Keynes’ own investment philosophy is worthy of an article in its own right. He started out as a pure animal spirits investor engaging in currency speculation during the initial breakdown of the Gold Standard in the early twenties and promptly went bust. He then moved onto something called the “credit theory of investment” which supposedly allowed the smart investor to swap between treasuries, cash and stocks based on a bunch of forward economic indicators: in essence an economist’s version of a beauty contest. Like so many other investors he learned the hard way that this didn’t work in ’29. Only after this did his investing style move radically towards value investing.

    As DIY Investor states, about Keynes' comments on animal spirits investing: “He was actually saying that this behavior is what is wrong with investment markets - investors do not look at the long run in making decisions."

    That’s true, but he was also, simultaneously, making the argument that if everyone does this – and relies purely on a “mathematical expectation” – then markets will fail for want of animal spirits. Speculation and enterprise are tangled together in a deathly embrace and it’s this that leads to boom and bust.

    DIY Investor also, correctly, states: “Actually Keynes didn't "propose" the beauty contest as an investment approach. He was describing how investors act.”

    Fair point: I’ve changed “proposed” to “described”. The remainder of the article, warts and all, will have to stay as a monument to my lack of tact :)

  8. Interpreting "animal spirits" seems to be an old chestnut. Richard Posner makes the same point in his review of Akerlof and Shiller's book of that title.

  9. It took me 5-10 years to train myself to ignore my emotions and the opinions of others. Then I created my rules to make sure I did not act out of those opinion influencers.

    It has helped make me a good value investor.

  10. It's clear reading Buffett's biography The Snowball that the man is at least Aspergic, if not a high functioning autistic.

    People wanting to copy Buffett will have to add that mental condition to 'am I a genius?' and 'was I born before stocks became sexy?' when asking searching questions of their chances of success.

  11. In the short run, the market is a voting machine. In the long run, it is a weighing machine.

    If it is possible to use financial statements to predict (at least on a statistical basis) the future performance of a company, then it is not necessary to judge shifts in the mood of the crowd - eventually the evidence will be plain for all to see.

  12. This is just great. I am a college student taking up Economics and this article and the comments just cleared me on some issues regarding Keynesian Theory of Mind. My other concern is regarding the Keynesian Model of Unemployment and Growth. Can somebody enlighten me about this one? Thanks!

  13. Keynes lost all his money trading because he sucked at trading. His Daddy bailed him out.

    He then took out his inferiority complex of losing all his money by trading by creating an entire economic theory where the other traders were not as smart as he was.

  14. Bonjour,
    Vous trouverez ci joint l'adresse de mon Blog (

    C'est une théorie mathématique de la conscience reliant très bien Art-Sciences-Mathématique.


    Dr Clovis Simard

  15. Theory of mind is a very old and very well developed topic in psychology and neuroscience. In fact there are two known neural networks in the brain - one you use when you can physically see the person and one you use when you interpret through symbols - as we do with investing and trading decisions.

    The latest neuroscience work show that traders who use ToM are better tape readers... and that study was done at Cal-Tech.

    Keynes was right - in the end all you want is for someone else to value an asset at a higher price. To best judge that, it helps to think of it directly as opposed to indirectly.

    Denise Shull
    The ReThink Group