Posts Tagged ‘behavioral finance’
With all the political noise, and now theatrics, around the upcoming implementation of the Affordable Care Act (ACA, aka Obamacare), there has been astonishingly little written about the investment implications of the substantial changes this law represents to health care finance. Into the breech strides Barry Ritholz with Investing Around Obamacare. Ritholz’s bottom line – mixing your politics with your investing is generally a losing strategy, and that healthcare, and hospitals in particular, are poised to outperform.
I was assuming that political analysts were in the business of making accurate predictions, whereas they’re really in a different line of business altogether. They’re in the business of flattering the prejudices of their base audience and they’re in the business of entertaining their base audience and accuracy is a side constraint.
University of Pennsylvania professor, Philip Tetlock, in his 2006 book on the subject. Nate Silver in his The Signal and The Noise, extended Professor Tetlock’s thesis to other disciplines, notably to investment market experts whose judgement was found to be no more accurate than that of their political counterparts. I note that the political experts in this quote, much like most financial experts, owe their allegiances wholly to their employers and not to the public. Thus their core business is earning returns for their employer and not returns for the consumer. This is a fundamental distinction that can lead to all sorts of havoc. And is why we urge investors to seek out professionals who operate with a fiduciary responsibility towards their clients.
Sarah Gordon, in the Financial Times (gated) writes that
There is a compelling body of evidence suggesting that the people most likely to go into the riskier areas of financial services are precisely those least suited to judging risk. Susan Cain’s recently published book Quiet cites a series of studies that suggest that extroverts tend to be attracted to the high-reward environments of investment banking, deals and trading. And, troublingly, these outgoing people also tend to be less effective at balancing opportunity and risk than some of their more introverted peers. …
As the financial crisis began to flower in 2007, [former Enron whistleblower] Mr Kaminski was interviewed by the Washington Post. He warned that the “demons of Enron” had not been exorcised. In particular, he complained that many who understood the risks that the US banks were taking were ignored because of their personality style. He said: “The problem is that, on one side, you have a rainmaker who is making lots of money for the company and is treated like a superstar, and on the other side you have an introverted nerd. So who do you think wins?”
Recent research, according to Ms Cain, suggests that there may even be an “extrovert gene” – one that regulates production of the hormone dopamine – which is associated with a particularly thrill-seeking version of extroversion and is a strong predictor of financial risk-taking.
In my own words, “Investing should be boring.” As an introvert myself (INTP for Meyers Briggs fans), I will add to the above Warren Buffett’s observation on investing from a Berkshire annual report many may years ago
Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.
A single cockroach will wreck the appeal of a bowl of cherries, but a cherry will do nothing at all for a bowl of cockroaches.
Daniel Kahneman, in Thinking Fast and Slow, quoting psychologist Paul Rozin
A striking observation for sure but one with great significance for behavioral psychology and behavioral finance as well. Kahneman uses this comparison as a simple example of how we react far more strongly to negatives (losses) than to positives (gains). Further research has shown conclusively that investors weigh losses more than gains, by a factor of up to two.