Behavioural Finance

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.

When you take your car in for a tune-up or yourself in for a check-up, you expect your mechanic and healthcare provider to know more than you do about their respective areas of expertise.

In 1931, Alfred Korzybski, an engineer, philosopher, and mathematician, presented a paper to the American Association for the Advancement of Science. In the paper, he introduced the idea that the map is not the territory. In other words, a model of a thing is not the thing itself.

It doesn’t take an expert to tell you the flip of a fair coin gives you 50/50 odds, heads or tails. What if I told you most market gurus fare even worse than a coin flip when it comes to making accurate financial forecasts? Would you continue to pay attention to their “expert” calls?

I visited my sister in the UK last summer and spent time with my young nieces and nephews. One evening, we found a compendium of board games and I introduced my five-year-old nephew to Snakes and Ladders. The rules were explained, although not completely absorbed, and off we started.

Academics are fascinated by the way you invest. You shouldn’t be flattered by their interest. They engage in sophisticated analysis in an effort to explain why you invest in a way that so irrational. The underlying premise of their studies is that your investing behavior makes no sense.