Behavioural Finance

The Myth: Everyone is piling into ETFs, and that makes stock markets less efficient. The argument: The more people invest through indexes and ETFs, the fewer people there are scrutinizing the fundamentals of stock prices to figure out if individual stocks are cheap or expensive. That must make it easier to pick stocks, right?

This is Episode 11 of the Rational Reminder Podcast with Cameron Passmore, Benjamin Felix and special guest Robb Engen of the Boomer and Echo blog.

Many of the reflexes that we innately have were very helpful when we were faced with predators in the stone age like saber-toothed tigers. But it turns out that evolution hasn’t prepared us well for facing the market economy.

It looks like once again, investing in commodities is in the news. Let me relate my encounters with commodity traders.

This discussion begins in 1906, at the Plymouth County Fair in England. Sir Francis Galton walks by a contest, where participants are asked to guess the weight of an ox. There are over 800 guesses; some from butchers and farmers, and many more from men and women with no expertise to inform their guesses.

The holy grail of investing is finding assets that are imperfectly correlated with each other. Adding assets that behave differently together in a portfolio improves the expected outcome.

Investing in index funds is obvious once you subscribe to the idea, but getting there is not always easy. The majority of Canadians still invest their money in actively managed mutual funds. From what I have seen, the acceptance of index investing typically follows four stages.

A piece titled The Psychology of Money written by Morgan Housel made its rounds on the internet in June. It was an excellent collection of 20 flaws, biases, and bad behaviors that the author has observed when people deal with money. I did not fully agree with flaw number 10.

Being bombarded with data, headlines, and predictions presented as being impactful to your financial well-being can evoke strong emotional responses from even the most experienced investors.

About 25 years ago, I received an email from a prospective graduate student. He informed me that he had an undergraduate degree in Computer Science, an MBA, and was currently working in the financial sector. He wanted me to be his supervisor and write a thesis on Computational Finance.