Tag: The Little Book of Behavioral Investing

The Little Book of Behavioral Investing: Right for the Wrong Reason, or Wrong for the Right Reason

Some years back, I was at an office event that coincidentally was being managed by an acquaintance. Everything was going well when suddenly the lights went off. The music stopped. People lined up at the juice stall groaned. The microphones of course became dysfunctional too. A company executive who had just launched into a rendition of “fun at work” came to an abrupt halt. The event management team managed to locate a battery operated microphone in about 5 minutes. Turned out it wasn’t working. Anyhow, the lights came back on in another minute and everyone got back to the fun and games.

Now why am I telling you this story? Here’s why. Except for the electricity glitch, the event was alright. The event manager came to me and I said (more out of politeness), “The event’s been good. We’ve had fun.” Response: “Thank you. Here’s my card … in case you need my services.” “Sure. What happened with the lights though?” “Yeah. Really bad luck. The lights are quite reliable otherwise.” And that’s when I went … Whoa! That’s not bad luck. That’s sheer unpreparedness. No way was I (or the office probably) hiring these guys ever, not with that attitude!

Cover of "The Alchemy of Finance (Wiley I...

So, coming to the moral of the story: self-attribution bias, as demonstrated by the event manager. It’s one of the behavioral pitfalls Montier discusses in Chapter 12 of the The Little Book of Behavioral Investing: How not to be your worst enemy. The second one is hindsight bias. Both insensate us from (a) recognizing our mistake, (b) accepting our mistake, and (c) remembering the lesson learned.

As expected, most investors are afflicted by both biases. If an investment decision bears rich fruit, they’re ecstatic about their skills. If the decision leads to a loss, it’s blamed on bad luck, an unpredictable market … anything but themselves. Granted, questioning your ability as an investor may prove detrimental to your self-worth but at the very least, investors must unbiassedly dissemble the rationale behind a bad decision to prevent a repeat performance.

That’s not to say that luck doesn’t count in the stock market. It does but many erroneous decisions are a consequence of inadequate research or incorrect analysis.
Montier quotes Jeremy Grantham, chief strategist at GMO, to demonstrate how little history means to the majority of investors. When asked, “Do you think we will learn anything from this turmoil?” he responded, “We will learn an enormous amount in the very short term, quite a bit in the medium term, and absolutely nothing in the long term. That would be the historical precedent.”

As always, our good friend Montier offers a practical solution for investors to curb these behavioral tendencies. George Soros, author of the Alchemy of Finance, proposed this approach: Keep a diary and record your decisions as well as the rationale behind those decisions – in real time. Montier takes it further: Map the outcomes of your decisions and the background reasoning into a quadrant diagram as follows:


Good outcome Bad outcome
Right reasoning Skill (perhaps) Bad luck
Wrong reasoning Good luck Mistake


This strategy also helps to overcome the hindsight bias – our tendency to think we knew what the outcome of a decision would be once the outcome is out. This is primarily why so many publications of bubble post-mortems appear on news channels and papers. The deliverers of this information are the very people who missed the signs in the first place. Anyone can be the wise aunt after disaster strikes. It means nothing.

Thankfully, technology offers an even simpler means of avoiding these biases, along with the other human weaknesses uncovered in this book. For example, the idea of dissecting their own investment strategy may seem too painful to some. Others may do it inaccurately by being too kind to themselves. Technology eliminates any ambiguity or pretense.

StockViz empowers its clients by leveraging technology that’s deeply rooted in the science of economics and investment methodologies. Recently, we had a customer use the iNoiseTrader, a Twitter account linked to ODIN, the trade entry terminal used by him. The way it works is simple: whenever a trade happens, a tweet is sent to this account which serves as the investor’s trade log. The investor can quickly match real events with his personal notes and identify occasions where behavior pitfalls have hurt his chances of success. He now has the opportunity to overcome these inclinations and build a more fail-proof investment plan. Sweet and effective, isn’t it?

Monica Samuel is doing a chapter-wise review of the book: The Little Book of Behavioral Investing: How not to be your worst enemy by James Montier. You can follow the series by following this tag: tlbbinvesting or by subscribing to this rss feed: tlbbifeed

The Little Book of Behavioral Investing: This Time is Different

Bubbles. Kids love them. Investors hate them. And if the rest of the populace understood their meaning in financial terms, they would hate ’em too. Especially in the current economic climate, largely the result of a bubble that blinded, muted and deafened us from the signs of a tornado in the making.

To be fair, words of dissent and caution did rise during the bubble of India’s accelerating growth, warning investors and leaders of impending danger. But as happens in the case of most bubbles, no one really listens. Instead, the harbinger of bad news becomes the target of jokes, rants, and career aspersions.

Cover of "The Little Book of Behavioral I...

A “bubble” in market parlance is defined as a real price movement at least two standard deviations from trend. But more than the definition, it’s the aftermath of the bubble that brings home the real meaning of the deadly phenomenon. We’re onto Chapter 11 of The Little Book of Behavioral Investing: How not to be your worst enemy. And the theme this time, as I’m sure you’ve guessed, is bubbles.

India is currently experiencing the repercussions of a debt-driven bubble gone bust. As Jayanti Ghosh, Professor of Economics and Chairperson at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi states: “The Indian economy may well be on the verge of a full-blown currency crisis.”

Inflation is biting the middle class from every side. With the price of basic amenities touching the sky, and the rupee-dollar rate making exporters jittery, we’re exhibiting the classic signs of “revulsion,” the terminal phase of John Stuart Mill‘s framework of a bubble. Let’s break that up:

Phase 1: Displacement: India’s potential is discovered by developing countries like US, UK, etc. Lots of capital flows in. Real estate and construction jump. Traded goods see a slump.

Phase 2: Bubble nurturing: As the boom grows, more investment options arise in non-trading sectors such as real estate and construction. Credit lines opened up for the masses, at low interest rates.

Phase 3: Euphoria: The general consensus is that the graph will continue rising. Investors abandon time-tested valuation methods and adopt new tools to justify the current price and trend. Over-confidence and over-optimism rule decisions as investors stop thinking about the logic and viability of their commitments. Everyone wants a slice of the pie.

Phase 4: Financial distress: Insiders start cashing out. Since June more than $12bn has been withdrawn by portfolio investors alone (ref). This is a phase when fraud and defaults abound and traders are forced to sell goods at basement prices to meet obligations.

Phase 5: Revulsion: Investors stay away from the market, needing time to recover from the shock. This leads to bargain basement asset prices. That’s where we’re at today.

Montier quotes Herb Stein’s (Chairman of the Council of Economic Advisers under Presidents Nixon and Ford) prophetic words to underscore the fatality of bubbles: “If something can’t go on forever, it won’t.” If the market looks too good to be true, it probably is.

Why, if the signs of a bubble are apparent to at least some market watchers, do investors get taken in? Sometimes it’s because professional investors must answer to clients and bosses who disagree with their cautious point of view. It becomes a choice between risking their career or their client’s money – an easy decision for most. And other times, investors are blinded by their own behavioral tendencies, namely:

  1. Over-optimism: Bad things only happen to other people. We’re good.
  2. Illusion of control: We can control the outcome of events, however high the probability of our loss if we measure the problem mathematically.
  3. Self-serving bias: We interpret information to suit our self-interest – keep the client happy (not that that’s going to last), listen to the boss, I need this job, etc.
  4. Myopia: We focus on the short-term versus long for palliative comfort. Why worry about tomorrow?
  5. Inattentional blindness: An interesting word that means we simply do not expect to see what we’re not looking for. Meaning that if a bear winged past while we were looking for that plane on the horizon, we probably wouldn’t notice.

Montier suggests investors keep the following points in mind to avoid succumbing to bubbles:

  1. Educate yourself on market history. The stories are horrifying enough to make you vigilant.
  2. Don’t assume bubbles are black swans. The signs are always visible, if you’re looking for them.

Bubble busts have broken economies before and the worst for us could still be ahead. Meanwhile, Montier suggests an action plan for investors – Watch the market for signs and do your own research. Don’t ignore circumstances for short-term gains because the long-term impact of a bubble can break you for good.



Monica Samuel is doing a chapter-wise review of the book: The Little Book of Behavioral Investing: How not to be your worst enemy by James Montier. You can follow the series by following this tag: tlbbinvesting or by subscribing to this rss feed: tlbbifeed



The Little Book of Behavioral Investing: The Siren Song of Stories

“Focusing on facts” is about as unexciting as this statement was mundane to read. I mean, facts are cold, lifeless things. They’ve no heart. They’re all for the C-system, starving our X-system of the emotional satiation of stories: stories that stir us with optimism, pleasure, disgust or fear – but stories that pull us in. If you’re a TV watcher, that’s all the news channels are into nowadays – stories of past, present and future, and very little fact. Sadly, what these stories don’t take us to in the investment journey is a happy ending.

Investors ahoy! Clog your ears from the siren song of stories!

Cover of "The Little Book of Behavioral I...

Humans are emotional beings. We’ve gone on about this attribute from Chapter 1 of The Little Book of Behavioral Investing: How not to be your worst enemy and this is certainly not the last time you’ll hear it. In the current Chapter 10, author James Montier highlights the risk in falling for stories and our inclination to draw inaccurate conclusions based on preconceptions.

Such as, you ask? “Expensive means it must be good.” Not true. Just like everything cheap isn’t always bad, everything expensive isn’t good either. Montier gives the example of IPOs. Almost always, IPOs are overpriced. While history has repeatedly shown that IPOs are generally terrible investments, constantly demonstrating long-term underperformance across the world, they continue to attract investors.

Why? Because what IPOs come with is a good story.

During 1980-2007 in USA, the average IPO underperformed the market by 21% in 3 years after its listing.

On similar lines … “admired stocks” – the one with big price tags and great stock market and financial performance stories get all the investor love. “Despised stocks” – typically low value and tagged with poor stories, are not considered good buys. Is that a biased thought or not? In reality, it’s found that usually the despised stocks are better investment – outperforming not only the admired stocks but also the market.

But how many investors go beyond the story? How many follow a reverse engineering approach to dissect the past performance of companies that launch pricey IPOs? How many get down to proving the validity of the current stock price?

Montier gives us an example of a medical story to prove its influence. Here’s a drug “A” whose effectiveness is given as a percentage of those cured overall – ranging from 90% to 30%. These stats are given to participants along with a positive, negative or ambiguous story. Remember that the base information or the facts of the drug’s efficacy has been laid out clearly. Participants were then asked if they would try the drug if afflicted by the disease:

  • For a 90% efficacy rate, after hearing a positive story – 88% were agreeable.
  • For a 90% efficacy rate, after hearing a negative story – only 39% agreed.
  • For a 30% efficacy rate, after hearing a negative story – only 7% agreed (expectedly).
  • For a 30% efficacy rate, after hearing a positive story – 78% were agreeable.

That’s the power of a story. It blinds you to facts.

Another example is used to describe the capitalization of hope. Hark back to 2003-2007 when China’s growth in production was making big news. The global mining sector suddenly became the new gold. Analysts predicted that earning per share would sky rocket at a rate of 12.5% per annum, double the rate seen historically. Those who bought the story invested. And then came the world’s largest downturn… leaving investors gasping.

See the root cause of all this trouble? It’s the enchantment of stories. So what’s our protection here? Focusing on facts – nothing more, nothing less. All investment decisions must be based on sound research that’s justified by facts, not market news and analysts’ humdrum. Stick with that and keep trouble away.


Monica Samuel is doing a chapter-wise review of the book: The Little Book of Behavioral Investing: How not to be your worst enemy by James Montier. You can follow the series by following this tag: tlbbinvesting or by subscribing to this rss feed: tlbbifeed


The Little Book of Behavioral Investing: Are you a perma-bear or perma-bull?

Holding on to our view is not a behavioral pitfall that plagues investors alone. It’s a fairly common characteristic of all humans. In the last chapter of The Little Book of Behavioral Investing: How not to be your worst enemy, James Montier pointed out the perils of the confirmatory bias. In this chapter, he talks about “conservatism” which in combination with the confirmatory bias becomes deadly for investors.

Cover of "The Little Book of Behavioral I...

Earlier in Chapter 6, Montier revealed the effect information has on our confidence levels. The more data we get to throw around in our head, the more confident we become of our decisions. However, access to increasing amounts of data does little to improve the accuracy of our final decision. Similarly, investors resist changing their sell or buy decisions once they’ve made up their minds. Even when new evidence comes to fore that implies their earlier decision may be flawed, they tend to under-react, selecting not to change their stand or do it very slowly – a behavioral pattern called “anchoring.”

Conservatism is also why perma-bears usually stay perma-bears for life as do perma-bulls. Anyone who tries to break this mold is subjected to abject torture. Well, not really. But certainly, the act does not get the approval of the respective sacrosanct groups. Why is that? It’s bad enough that we’re not flexible in our decision-making process. Do we also need to pull down those who dare to be different? It’s a truth that reigns across the globe. Sacred wars, hatred killings, road rage, social ostracism – aren’t all these a more extreme form of intolerance for different opinions and practices? But let me not go off on a tangent.

Montier links the attitudes of perma-bears to conservatism. They are always negative about the market and weirdly enough, have nothing to do with money management on the ground. These people are highly paid for their pessimistic discourses and market trend postmortems. They’re respected and ardently followed. What you learn from them is to be afraid. Stay scared, stay safe. And where does that take you in the investor’s world? Not very far from where you started.

The absurdity of investor conservatism was on naked display recently when ex-Merrill, and now Gluskin Sheff’s Chief Economist, David Rosenberg recently got more constructive on the economy and the markets this year. Investors who followed his briefs were mad at him for “abandoning” them. “It was never about his analysis; it was always about him adding intellectual heft to their pessimism and quasi-political partially religious desire for the collapse of the system. Their worldview was that things were in permanent decline and his sophisticated charts added a veneer of respectability to their pre-existing biases,” says Joshua M Brown on StockTwits.

And as David’s rigorous analysis forced him to warm to the possibility of a healthy investing environment, they flipped out and turned on him. They were not mad at him for being wrong, they were mad at him for changing his mind!

Risk is part of this game and if you can’t handle it, you’ve no business here. That’s not to say that you go crazy with your investment portfolio. This means that you be willing to:

  1. admit that your initial view may be wrong,
  2. re-validate your position based on current research and close out possible losses, and
  3. take small risks for big gains.

How does that work?

Montier believes conservatism is why many investors miss out on vital turning points in the market. Since we don’t like change, we under-react to things that may compel us to revisit our decisions. When the market is unstable, investors hold their breath, waiting for the worst to pass. In the process, they miss precise signals that could get them big returns in time. Remember Chapter 2 – tagging companies worth investing if their price fell? Unstable markets are ripe with such opportunities.

Mistakenly, investors tend to overreact to every trend when the market is stable – a time when it’s best to turn down the noise. It’s a completely skewed strategy.

Beating conservatism is hard, terribly hard. Montier suggests a solution to beat ourselves in the game – start with a fresh slate. Recreate your investment cases based on current research and facts. If companies that figured in your initial plan are missing, it’s best to let them go.

In short, the market doesn’t care about your personal beliefs. And just like how cricket commentary doesn’t change the outcome of a match, pundits don’t make markets. Don’t lose sight of the fact that the goal is to earn a reasonable return on your investment.


Monica Samuel is doing a chapter-wise review of the book: The Little Book of Behavioral Investing: How not to be your worst enemy by James Montier. You can follow the series by following this tag: tlbbinvesting or by subscribing to this rss feed: tlbbifeed

The Little Book of Behavioral Investing: See No Evil, Hear No Evil

Time to prove yourself wrong

How sure are you of your convictions? If I present evidence that refutes your belief, how would you take it? Would you consider my point and argue your case with logic and reason? Or would you stick with your own version because it’s more comforting? Much as we’d like to believe that we fall in the first group, most of us don’t. Again, we’re weighed down by habit. This one is called the “confirmatory bias.”

Cover of "The Little Book of Behavioral I...

In Chapter 8 of The Little Book of Behavioral Investing: How not to be your worst enemy, James Montier discusses our tendency to look for evidence that confirms thoughts or insights that agree with us. We practice this to a point where we even bend newfound information to suit our preferences.

Annoying “know-it-alls” (Who isn’t plagued by them?) always have a string of stories and purported facts to push their claims or unasked-for advice. Their art is so convincing that you almost believe they know what they’re about. But contradict them with one fact, try to break their story … and you’ll be facing hours of baseless argument and indignation. Now, the know-it-alls are irksome pests, no doubt, but we’re guilty of the same conduct … at a deeper, self-deceiving level.

When we come to a conclusion on any subject, we unconsciously deviate towards evidence that supports it rather than that which breaks it.

Let’s say you’re looking for houses in a locality you believe is the best fit for your needs. You ask around. Some people say nice things about the area, and you feel happy and contented about your decision. You hear a few moaners too but that’s what they are, right? Moaners. Everyone can’t be happy! But what if you focused on their moaning and researched some more to break your own conviction? I agree, it’s a depressing thought … it’s going to be hard going, unexciting, and it might kill your own plan but consider this: What if you unearth information that saves you from a huge mistake you’d regret all your life?

The internet makes it even harder for us to be open to ideas that are at odds with our personal values. We follow tweets of people whose thoughts align with what we deem right or wrong. The Facebook newsfeed algorithm shows us stories that we “liked” in the past. It’s easy to slip into a self-curated cocoon where we never hear an idea that compels us towards unlikely streams of thought.

Breaking our own analysis – that’s something we never do, at least not willingly and certainly not happily. Many of my friends believe that buying “luxury” flats is a good long-term investment. The idea is so ingrained that it’s like the gospel truth among the IT crowd. Even though research (by a Nobel Prize winning economist no less) proves housing isn’t good investment, I am looked upon as a joker who doesn’t “get it” when I oppose popular view. Almost every flat-owner I know has at least a dozen anecdotes about people who make a “killing” investing in flats. Throw the numbers on a spreadsheet and their enthusiasm quickly fades away. But despite it all, the belief sticks.

That’s our problem. We move away from an opposite point of view. And the more data we access, the more polarized our opinions become. Furthermore, the “biased assimilation” enhances our confidence, all in the wrong direction. It’s a behavioral pitfall that’s annihilated the fortunes of individuals and businesses since ages.

On the other side, there are people like Charles Darwin. He’s the guy who scientifically verified the theory of evolution, explaining our often apelike behavior. His announcement created an uproar in civil society and many opposed his analysis. Did that discourage him? No. Instead, he intensely researched evidence that contradicted his theory, to understand how it fit in.

That’s what an investor needs to do too.

Bruce Berkowitz of Fairholme Capital Management advises investors to look for information that kills a company as opposed to that which supports it. Think of the ways a company can go down – for internal or external reasons, bad strategy, accidents, natural disasters – and verify how well it’s prepared for contingencies. If the company survives the grueling analysis, then maybe it’s worth something.

Many people would call this a “negative” approach. But believe me, it’s that negative attitude that’ll save you in the big bad market. Cultivating this habit will be hard going, especially for the eternal optimists. But did I say becoming a good investor was easy?


Monica Samuel is doing a chapter-wise review of the book: The Little Book of Behavioral Investing: How not to be your worst enemy by James Montier. You can follow the series by following this tag: tlbbinvesting or by subscribing to this rss feed: tlbbifeed