We Was Robbed

Worst Call EverOn June 21, 1932, after Max Schmeling lost his heavyweight boxing title to Jack Sharkey on a controversial split-decision, his manager Joe Jacobs famously intoned, “We was robbed.” It’s a conviction that hits home with every fan of a losing team and thus every sports fan a lot of the time. It’s also a point of view that has received a surprising amount of academic interest and study (note, for example, this famous 1954 paper arising out of a Dartmouth v. Princeton football game).

Traditional economic theory insists that we humans are rational actors making rational decisions amidst uncertainty in order to maximize our marginal utility. As if. We are remarkably crazy a lot of the time.

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We Are Less Than Rational

Investment Belief #3: We aren’t nearly as rational as we assume

InvestmentBeliefssm2 (2)Traditional economic theory insists that we humans are rational actors making rational decisions amidst uncertainty in order to maximize our marginal utility. Sometimes we even try to believe it.  But we aren’t nearly as rational as we tend to assume. We frequently delude ourselves and are readily manipulated – a fact that the advertising industry is eager to exploit.1

Watch Mad Men‘s Don Draper (Jon Hamm) use the emotional power of words to sell a couple of Kodak executives on himself and his firm while turning what they perceive to be a technological achievement (the “wheel”) into something much richer and more compelling – the “carousel.”

Those Kodak guys will hire Draper, of course, but their decision-making will hardly be rational. Homo economicus is thus a myth. But, of course, we already knew that. Even young and inexperienced investors can recognize that after just a brief exposure to the real world markets. The “rational man” is as non-existent as the Loch Ness Monster, Bigfoot and (perhaps) moderate Republicans.  Yet the idea that we’re essentially rational creatures is a very seductive myth, especially as and when we relate the concept to ourselves (few lose money preying on another’s ego). We love to think that we’re rational actors carefully examining and weighing the available evidence in order to reach the best possible conclusions.

Oh that it were so. If we aren’t really careful, we will remain deluded that we see things as they really are. The truth is that we see things the way we really are. I frequently note that investing successfully is very difficult. And so it is. But the reasons why that is so go well beyond the technical aspects of investing. Sometimes it is retaining honesty, lucidity and simplicity – seeing what is really there – that is what’s so hard. Continue reading

Hope for the Future

HopeFutureNearly every high school choral organization routinely performs anthems based upon some version of a familiar trope. The piece is designed to be trendy musically, even while being more than a bit late (when I was in school, each had an obligatory “hard rock” section). Meanwhile, the lyrics are an earnest and perhaps cloying ode to the ability of the young to create a better and brighter tomorrow. One such title from my school days was in fact “Hope for the Future.”

Unfortunately, the promise always seems better than the execution.

Despite the enormous (and most often negative) impact that our behavioral and cognitive biases have on our thinking and decision-making, the prevailing view is that we can’t do very much about them. In his famous 1974 Cal Tech commencement address, the great physicist Richard Feynman emphasized the importance of getting the real scoop about things, but lamented how hard it can be to accomplish.  “The first principle is that you must not fool yourself – and you are the easiest person to fool.” Even Daniel Kahneman, Nobel laureate, the world’s leading authority on this subject and probably the world’s greatest psychologist, has concluded that we can’t do much to help ourselves in this regard.

But today — maybe — there might just be a tiny glimmer of hope (for the future). Continue reading

Who’s the Easiest Person to Fool?

RES_1213_AnnuityAnalytics_MI600-resize-600x338My December Research magazine column is now available online. Here’s a taste.

Innovation in financial planning typically starts with an idea. If enough people (or the right people) think it might be a good idea, it then moves to evidence-gathering for confirmation. But the entire endeavor—designed to try to confirm if the idea makes sense—is inherently prone to confirmation bias. We should be systematically and consistently looking to disprove the idea. Without a devil’s advocate with the specific mission to try to show why the idea is a bad one, without recrimination or criticism for doing so, many bad ideas will seem to be confirmed.

I hope you will read the whole thing.

Who’s the Easiest Person to Fool?

Too Sure By Half

Nobel economistsAll nine of this year’s American Nobel Prize laureates shared a stage this week. Not surprisingly, economists Robert Shiller and Eugene Fama sniped at each other, if good-naturedly. But it was the winners from the harder sciences who got the best digs in at the economists. Martin Karplus, a chemist from Harvard, queried, “What understanding of the stock market do you really have?” He even went so far as to note that economics – “if one wants to call it a science” – seemed completely unable to explain market movement. There were others, but you get the point.

The obvious takeaway is a common theme – that economics is conflicted flawed divided wildly inconsistent worthless, a point that has been made by Nassim Taleb, Jeremy Grantham and many others. The idea is that economics desperately wants to be a science, with “physics envy,” but simply isn’t up to the task. And it’s hard to contest the point.

My disagreement is not so much with the main point (even though I think academic economics has a good deal to offer, with Shiller’s work being Exhibit A in my evidence cache), but with its corollary and the casual certainty with which that corollary is expressed.  “Hard” scientists increasingly express a belief that their domain is the only bastion of reality available. They see a great divide between things we can know (science) and everything else, which is opinion at best and largely worthless. That the expression of it is so often humorless and irony-challenged makes it all the worse. Continue reading

The Wyatt Earp Effect

The Big PictureMy first post for The Big Picture, the wonderful blog from Barry Ritholtz, also of The Washington Post and Bloomberg View, is now up. You may read it here. I hope you will.

The Wyatt Earp Effect

Mean Reversion Wins Again

HogeRight after his terrific Super Bowl winning performance, Joe Flacco was deemed the best quarterback in the NFL by ESPN “expert” Merril Hoge.

During presentations on cognitive biases and their impact on investment decision-making throughout this year, I have been using this claim as a great example of recency bias and of a likely failure to understand mean reversion. Flacco’s performance so far this season makes the point.

Flacco was fantastic in the play-offs last season, leading the Baltimore Ravens to a title by throwing 11 touchdowns with no interceptions over that time and averaging a terrific 9.05 yards per attempt. His QBR was 84.4 and his QB Rating was 117.2.  However, in the 80 regular-season games before that, and through the 2013 season to this point, Flacco has been and remains an average NFL quarterback {115 TDs to 74 interceptions (13/13 this year); 7.01 yards per attempt (6.55 this year); 51.7 QBR; 84.9 QB Rating (48.3/75.3 this year)}. Despite the four play-off games that suggested he might be an emerging superstar, I argued, beginning last winter, that his performance would likely revert to his mean, long-term performance. And so it did.

It is possible that near-term aberrations in performance reflect a major change in long-term norms that can be continued going forward. But that’s not usually the case. As Dennis Green (then coach of the Arizona Cardinals) famously expressed it, “They are who we thought they were” most of the time and that doesn’t tend to change all that much.


The market corollary to this idea is that when prices are very high they will tend to decline and when they are very low they will tend to rise. Since our objective generally is to buy low and sell high, making good investment decisions in this regard should be pretty easy then, right? Sadly, the answer is a clear no.

Recency bias is our tendency to put too much emphasis upon the recent past to the exclusion of the full data set and to extrapolate recent events into the future indefinitely. Professionals are no less prone to its effects as anyone else. As reported by Bespoke, Bloomberg surveys market strategists on a weekly basis and asks for their recommended portfolio weightings of stocks, bonds and cash.  The peak recommended stock weighting came just after the peak of the internet bubble in early 2001 while the lowest recommeded weighting came just after the lows of the financial crisis. Obviously, following that advice would have been a big mistake and had an investor sold stocks at the peak stock weighting and bought at the rock-bottom weighting – doing the opposite of what the experts said – s/he would have done exceptionally well.

Emotionally, we get afraid when markets tank and euphoric (greedy) when markets are hot. No matter how quick we are to agree with Warren Buffet conceptually (“Be fearful when others are greedy, and greedy when others are fearful”), it’s really hard to do. The financial markets are the only places I know where people want to pay top dollar and resist buying anything on sale. Where else do people want to wait for prices to go up before they buy? That’s largely on account of recency bias and our emotions. Ravens fans were angry when mean reversion was discussed in connection with Joe Flacco’s play-off performance last season. But the numbers don’t lie. He’s still who we thought he was.

The Myth of the Rational Investor

rcm_logo_followMy latest Real Clear Markets piece is available here. A taste follows.

Homo economicus is a myth, of course. But it’s a very seductive myth, especially as and when we relate the concept to ourselves. We like to think that we’re rational actors carefully examining and weighing the evidence in order to reach the best possible conclusions. Oh that it were so.

Here’s the money quote: “Information may be cheap, but meaning is expensive and elusive.”

Better Investing Requires A Broad Perspective

Investment Learning from the Law

lawI went to law school on account of certain skills I possessed – some general academic talent, analytical and writing skills, the ability to marshal arguments, and very good standardized test-taking ability. But I didn’t really understand what attorneys did in any meaningful sense.  Indeed, I had never met one before enrolling in law school at Duke.

As it turned out, I became a pretty good attorney – my skill set was appropriate.  But I never liked it very much and I was better suited for this business.  I favor accommodation, collegiality and collaboration to conflict. I’m better at big picture trends and goals than I am at minute details. I prefer adding value to playing zero sum games. I have a much shorter attention span than the litigation process permits. So I now refer to myself often as a recovering attorney.

But my legal training has helped me in this business in a number of clearly definable ways. Indeed, law school provided a pretty good education for a budding investment professional. I outline five specific and interrelated investment lessons I’ve learned from my legal training and experience below.
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Personal Bias

BiasedGrantland has an excellent long form piece up about the lingering racism of Valdosta, Georgia as it relates to the mysterious death of a young athlete there. The article is excellent and worth reading for multiple reasons. For our purposes, I was particularly struck by the following two paragraphs.  Continue reading