How to Use Behavioral Finance in Asset Management, Part III

This is my third and final installment in our look at deploying what we have learned from behavioral economics in the everyday practice of financial planning and asset management.

Today, we look at how we interact with the investing public — and why. This includes investors, regulators, the media, academia, really, anyone interested in finance. It is clear to those who have studied the history of investing just how much behavior matters — the biggest source of “unforced errors” come from the many ways people allow their hard-wiring / wetware to lead them towards very questionable decision-making.

There is a huge pool of people who need some assistance in understanding how to manage their own money, whether or not they are in the tiny percentage (<1%) of readers who might eventually become RWM clients.

The ugly truth: there is an enormous contingency of players who do not have your best interests at heart. Whether they are trying to sell you a product, or get you to watch, listen or click on something, the giant bullshit industrial complex is working against you.  And, they are expert at pushing the hot buttons hard-wired into you that is part of your evolutionary inheritance. Part of our jobs when dealing with the public is countering that machinery.

This is why we try to teach how to think (not what to think). That is where we start today:

1. Thinking: Most people have a fundamental misunderstanding about what money is, what purposes the markets serve, and what they are supposed to be doing in that space. Their beliefs are based on thinking that is imprecise and often inaccurate. Appeals to emotion are rampant in finance marketing, but we have behavioral tools to counter that.

Markets do not exist so you can prove how smart you are, or for you to show your belief in (fill in the blank), or to provide cocktail party chatter. It is not a contest, at least not the sort of contest that gets portrayed on television. Markets are a place for companies that need capital to grow to meet the people who have that capital, and a willingness to put it at risk to obtain a return.

Once people learn how to think, once they develop their own analytical framework, they can see through the bullshit machinery on their own.

2. Beta vs Alpha: Beta is cheap and easy, Alpha is expensive and hard. Beta appeals to the intellect, alpha is emotional. Everybody has the ability to find beta; nearly no one has the ability to find alpha. Beta is a humble approach to markets, a more honest recognition of the limits of your talent and personality type. Alpha ignores the probabilities, assuming they will beat those odds to obtain the holy grail.

People who create alpha are exceedingly rare; people who can identify them in advance are rarer still. Why should any of us assume we are in either camp? Understanding this gives investors the greatest probability of succeeding.

3. Media: The way we use our platforms in the mass media is to provide interesting and intelligent commentary that avoids the sensational and emotional. We try to be a smart counter-weight to what else is out there. Watch Josh on Halftime Report — he is the voice of reason in a sea of emotions, getting people to think about slow money on a show that is about fast money (it’s quite the trick). Listen to the discussions Mike and Ben have on Animal Spirits — they may be fun, but they focus on what matters and teach people about better investing (they also do a nice job debunking a lot of nonsense). Our blogs all consistently do the same.

My pet peeve has always been the ephemeral, meaningless focus of so much FinTV: “Whats your favorite stock? Where will the Dow be in a year? When will the Fed next raise rates?” These are questions you will never hear me ask on MIB. Instead, I use that platform to discuss finance in ways few others do. It has become a grad school level business and investing course taught by legends of investing and business.

This is proof you don’t have to engage in the sort of outrageous nonsense we see everyday to attract an audience or get people to click or maintain a large media presence.

4. Evidence-Based: Investing based on actual data leads to much better decision-making (and therefor results)  rather than by myth or emotion. Debunking bad ideas, misleading memes, silly television tropes, and other assorted nonsense is an important and worthy goal of ours. Explaining how and why people make bad decisions can only lead to smarter investors. It is why we hosted the Evidence Based Investing Conferences, and why we always push back in public on so much nonsense. When the public sees this approach, they quickly realize how much nonsense everything else is.

5. Cycles: Markets are cyclical, recessions (outside of Australia) occur once a decade or so; drawdowns are a regular feature of equities, and crashes are inevitable. Once people understand these events are normal and natural, they are less likely to overreact or make bad emotional decisions due to fear or panic.


I am now at my self-imposed 1000 word limit, so I will stop here. If you want to learn more about behavior and investing, see these posts, or WaPo or Bloomberg columns. Or contact us at the tab above.



How to Use Behavioral Finance in Asset Management:

Part I

Part II

Part III

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