Behavioural Finance

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.

Investors engage in very curious behavior. It’s increasingly difficult to understand why this occurs. Here are some examples:

The rapid rise in price of Bitcoin has generated intense speculation about the future of cryptocurrencies. It’s instructive to take a closer look at some of the commentary about the future price of Bitcoin, because it tells you a lot about speculation, investing and financial journalism.

Over the years, I’ve written extensively on how to invest intelligently and responsibly, based on sound, peer-reviewed evidence. Together with many others, I’ve extolled the virtues of low management fee index funds, global diversification, keeping costs and fees as low as possible and avoiding or deferring taxes.

For many years, I’ve viewed the behavior of most investors as inexplicable. Here’s a summary of their bad choices.