Investment Junk Food

Easy and instant access to information is often framed as a major advantage to present day investors compared to their predecessors, but if anything we suffer from a profound information disadvantage. The benefit of improved knowledge is easily overwhelmed by the behavioural challenge of dealing with an incessant torrent of noise. Much of what investors consume is little more than investment junk food, tempting us into decisions that feel good in the moment but come with a material long-term cost.

Whether it be an update on why the stock market closed lower today, a vivid description of a new and profound economic theme, or a compelling account of why we are headed for a recession, such communication bears a striking resemblance to the attractions and dangers of junk food. It provides us with a quick fix, is more interesting than the stuff that does us good and can create long-term damage.

Not only is it appealing, it is everywhere. Investment junk food is prolific. It is like being in a supermarket with row upon row of cakes and ice cream, with the fruit and vegetables hidden on a shelf in the back corner. Making smart decisions in such an environment is incredibly difficult.

The driving force of this problem is incentives. Investment junk food is created for usually one of two reasons – raising assets or attracting eyeballs. The primary motivation is not typically to improve our long-term financial health, but to profit from us in some fashion.

While the occasional chocolate bar is unlikely to be of detriment to our long-term well-being; investment junk food can be more pernicious. Seemingly small, in the moment, mistakes can compound into dramatic long-run costs. This torrent of unhelpful communication matters and is far from benign.

Financial markets are a natural and compelling storybook. A constant stream of heroes, villains, opportunities, threats, failures and successes. This makes them captivating and intriguing – the perfect setting for creating investment junk food.  There is always a new story to tell and sell.

One of the major behavioural problems investors encounter is mistaking the ceaseless action in markets as a call to action in our portfolios. If something is happening in markets, then something should be happening in our portfolios. Investment junk food preys on this misconception. It tells us that things are changing and asks us why we are not doing anything about it.

For most investors financial markets should be chaotic and fascinating, but our portfolios should be stable and dull.

The most common defence of the industrial production of investment junk food is that clients demand it, so it must be produced. If we didn’t tell them how the stock market performed last month, they would demand to know why. There may be some truth to this, but it is also a vicious circle. Clients want it because they are continually fed it. Perhaps we could try reframing those expectations and talking more about good investment behaviour.

The problem with these fruits and vegetables of the investment communication world, is that they can seem repetitive and dull, much like good, long-term investing. There are two solutions to this – communicating the same messages in different ways (which certain people do exceptionally well). Or by telling people about all the enthralling and emotive things that are happening in financial markets, and then why they should not be doing anything about it.

We can look at the junk food, but just not eat it.

My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

New Podcast Episode – Diversity and Decision Making

In the latest episode of the Decision Nerds podcast, Paul Richards and I explore one of the most important subjects in the asset management industry – diversity and inclusion – with Tom Gosling. Tom is a committed and thoughtful supporter of D&I. A practitioner turned academic who helps build bridges between researchers, policymakers and those at the coal face.

He has a thoughtful take on some important strategic and practical D&I issues. In the episode, we discuss:

– Why overstating the business case for diversity (improved profitability or alpha) may be more harmful than beneficial.

– Why the moral, social and economic arguments for diversity may be stronger but are not talked about enough.

– How to make genuine and substantive change around diversity and avoid a culture of box ticking.

– What more diverse teams mean for performance.

– How we can create decision making environments that make the most of the advantages of diverse teams.

This is a fascinating and important subject from both a macro (social justice / fairness) and micro (how do diverse groups function) perspective. The issue is far more complex than we could hope to do justice to in a single podcast episode, but we hope that it is a useful starting point for further debate and discussion.

You can listen here: Decision Nerds

Things Professional Investors Should Say but Can’t

One of the main challenges faced by professional investors is that good behaviours are often in direct conflict with our own interests. This is either because our incentives are misaligned – what’s beneficial for the business or my career is not necessarily good for my client – or we feel compelled to meet the erroneous expectations of what good investing behaviour is. This profound dissonance means that there are plenty of things that professional investors should be saying, but really can’t.

Such as:

“Sorry, I am not sure how the market did yesterday, I didn’t check.”

“Yes, this is the second quarter in a row where we haven’t made any changes to your portfolio. I hope we don’t make any all year.”

“You could listen to me talk about inflation, but I am just as bad at forecasting it as everyone else.”

“We are managing too much money, its probably not in your best interests to invest with us.”

“Our recent strong performance is totally unsustainable.”

“I have to admit, we have been incredibly lucky”.

“Our new CEO is really focused on improving short-term performance.”

“The performance fee structure means that I can become very rich, even if I underperform.”

“There really is little value in complexity, you are better off keeping it simple.”

“Yes, I have kept a record of my macro forecasts and trades, would you like to see it?”

“If you want to take a genuinely long-term, active approach, you will have to put up with years of underperformance. Even if we are good.”

“Although I say I have a long-term investing horizon, most of my decision are about keeping my job for another year.”

“To tell you the truth, this merger has been an absolute nightmare.”

“The recent team restructure has changed everything, we have lost some of our best people”

“I have no idea how markets will perform over the next year, and neither does anyone else.”

Although these issues can seem minor and akin to the classic sales activity of any industry – highlighting the perceived virtues of a product or service – there is something more damaging going on here. Incentives drive behaviour and too often the incentives of professional investors are pointed in the opposite direction of their clients.

My first book has been published. The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

Should Investors Trust Their Gut?

Investors often talk about making a decision based on a feeling in their gut. Explaining how some form of unconscious intuition led them to the correct choice.  Although this is an appealing notion – particularly as people only seem to mention it following success – it can also be a dangerous one. Should investors really be trusting their gut and, if so, when?

In 2009, psychologists Gary Klein and Daniel Kahneman published a paper called: “Conditions for Intuitive Expertise: A Failure to Disagree”. This work was particularly notable as the two authors had seemingly ideologically opposed views on the subject of intuitive judgements. Klein had focused much of his career on how experts often make high quality, snap judgements; whereas Kahneman had famously highlighted the flaws and biases inherent in such short-term views (often referred to as system one thinking).

Despite these seemingly polar opposite opinions on intuition, Klein and Kahneman found that they concurred much more than they disagreed. Their common ground can tell us a lot about whether and when we should rely on our intuition.

Klein’s view on intuition is defined as the study of ‘naturalistic decision making’, the genesis of which came from the observation of chess grandmasters and their ability to make robust, instinctive decisions. This work expanded into other fields where similar expert intuition was found to be in evidence – such as a fire chief anticipating the collapse of a building, or a nurse rapidly identifying a child with a dangerous infection.

This type of expert intuition is a form of pattern recognition, where we draw on historic experience to the extent that it becomes an ingrained, unconscious feature of how we reach a judgement.

Contrastingly, Kahneman’s perspective was trained on heuristics and biases – how our instantaneous judgements are often partial, noisy and flawed. Such mistakes in thinking were made by esteemed and experienced experts such as clinicians, political forecasters and – unbelievably – investors.

In one instance we have individuals able to make strong intuitive judgements, even in stressful and uncertain environments; in another we have our intuitions leading us horribly astray. How can we align these seemingly diametrically opposed stances?

The answer is that whether or not we trust our gut is dependent on the context of the decision.

Klein and Kahneman agreed that there were two critical conditions, which needed to be in-place for expert intuition to be effective:

– It must be a ‘high validity’ environment: ‘High validity’ seems a somewhat impenetrable term but is relatively simple. To quote directly from the paper: “Skilled intuitions will only develop in an environment of sufficient regularity, which provides valid cues to the situation”. Good intuition relies on some form of stable relationship between cause and effect; these don’t have to be perfect but need to be reasonably predictable. Despite a chaotic environment, there are a set of signals that might indicate to a firefighter that a building is about to collapse.

– There must be an opportunity to learn: Intuition is about recognizing patterns, so we must have enough opportunities to learn those patterns and receive feedback. It is very dangerous to develop intuition based on small but highly salient examples.

It is easy to see how investors can fall foul of gut feel choices. We are constantly making decisions in low validity environments – where conditions are unstable, noisy and prone to change through time. The patterns we observe in one period may not repeat in another.

Does that mean that investors should never be led by their gut? Not quite. It depends on what the intuition relates to. If we have a feeling that we are about to enter another bear market for stocks, this is likely to be entirely erroneous – such views meet both criteria of where intuition fails us.

If, however, we have a gut feel that investing in an asset class that has risen stratospherically over the past year is likely to be a bad idea, this is more likely to be a smart intuitive judgment. Why? Because there is far more validity in this situation – regular historic patterns of assets with spectacular performance subsequently disappointing.

As Klein and Kahneman point out, high validity does not mean that every intuitive decision will be right, but they will put the odds on our side over time.

The challenge for investors is to know when to trust our gut and when to ignore it. We almost inevitably make more intuitive judgements than we care to admit. Often making up our mind immediately, before carrying out some more detailed (after the fact) work to disguise the real driver of our choice.

The other major issue faced by investors is the conflation of intuition and emotion. They are both decision-making factors that can lead us to act quickly, but they are very different. Making a choice based on fear, greed, anxiety or excitement can feel something like intuition but has little to do with pattern recognition and all to do with biology. We should always avoid emotion-laden investment decisions.

The relief for investors is that – unlike the firefighter or the nurse – most of us don’t have to make snap judgements, we have time on our side even if we often don’t act like it. This doesn’t mean we should entirely ignore our gut but use the time we have to think about what it is telling us and whether it is the right type of situation to trust it.

Kahneman, D., & Klein, G. (2009). Conditions for Intuitive Expertise: A Failure to Disagree. American Psychologist, 64(6), 515.

My first book has just been published! The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

New Decision Nerds Episode – F&^% Ups

We all make mistakes, some big and some small.

Understanding how errors happen and how they can be managed is a critical element of good decision making. Whether in investing or everyday life.

In this bite-size episode of Decision Nerds, Paul Richards and I tackle this by examining the curious case of the ultra-marathon runner who got in a car. Getting in a car wasn’t the problem – the fact that it was in a race and that she took a podium position was. Several days later, she had to apologise and explain what had happened with all the grief, Twitter pile-ons and general angst that you might expect.

Was this a case of a cynical cheat getting caught, or an example of when environmental factors can lead to a poor decision that spirals out of control? Our take is that it’s probably the latter and we’d all do well to learn what we can from this unfortunate situation so that we can manage our own errors more effectively.
We discuss:

The crucial role of the decision environment – the impact of factors such as tiredness, anxiety, emotions etc.

Short-term, ‘in the moment’, thinking – how we often act to satisfy short-term needs and neglect the long-term costs of our choices.

The compounding effect – how small errors can become big problems.

Sharing the burden – how getting others involved quickly can make things easier, but why we might need strong incentives to do this.

Available through all your favourite pod places, or stream it here

We Have Expected Goals, What About Expected Alpha?

The football (soccer) team you support has just lost another game. You watch an interview with the manager (coach) and they lament their bad fortune. They dominated the match, had countless chances to score, but were just unlucky. Is this true or are they just trying to mask another bad performance? To answer that question, there is a metric that can help. Expected Goals (xG) has become widely used in football and hockey in recent years. xG tells us the number of goals a team should have scored based on the quality of opportunities created. As with all metrics it is imperfect, but it does provide invaluable help in disentangling skill from luck. Fund management is another area where we have severe difficulties in seeing beyond randomness and chance. Could a metric like xG help, and how might it work?

xG models are complex, but what they are trying to achieve is simple. For every chance created in a game a likelihood of scoring will be ascribed to it, creating an ‘expected goal’ between 0-1.  These probabilities are derived from analysis of historic scenarios. For example, the long-run conversion success rate of a penalty kick is 80%, so, if your team is awarded a penalty, that will result in an xG of 0.8 (whether or not they go on to score).

Why is this information useful? There are three main benefits:

– It provides an insight as to whether a team is underachieving or overachieving (or are perhaps experiencing good or bad luck).

– It may highlight if a team is unusually strong or weak in the most important aspect of the game – do they persistently overshoot their xG, scoring more goals than the model suggests they should?

– It can highlight where a team is going right or wrong. Maybe it is not that they cannot shoot, they don’t even create any good chances to score. 

There is still a great deal of judgement required here – is my team unlucky or terrible at shooting? But just because a metric doesn’t give us a finite answer, doesn’t mean it is not useful.

Investors in active funds are wrestling with many of the issues that the xG metric seeks to address in sport. Are results more a consequence of luck or skill? What are reasonable expectations for performance?

The problem of using a similar idea in investing is that it is a far noisier activity than football. A complex adaptive system, compared to a discrete game with fixed rules and a vast evidence base of similar situations. This distinction, however, does not mean that employing such a concept for active fund investing is without merit. The underlying problem statement is very similar:

xG in football:  Given the opportunity, what was a reasonable expectation for a goal to have been scored?

‘Expected alpha’ in investing: Given the opportunity set, what was a reasonable expectation for a fund manager’s performance?

How do we go about estimating how much alpha a manager should have delivered over a period? There are two possible methods:

Top-down / factor based: In this approach, we can use historic returns to describe a fund manager’s results as sensitivities to various factors (value, quality, momentum, size etc…). We can then compare the performance of their fund to a simplified version of their strategy based on the returns to those factor exposures.

The advantage of this technique is that it is reasonably simple to build a model that is consistent with the historic factor sensitivities of a fund. The downside is that a performance track record of some length is required, and, for some managers, it may be difficult to capture their results through factor exposures. This might be because they carry lots of idiosyncratic risk, or their style shifts through time. Such situations will, however, be in the minority.  

Bottom-up / fundamental:  A more robust approach is to create a systematic replica of the manager’s approach (all fund managers should do this anyway). To do this we would need to understand the investment process in detail – characteristics of the securities purchased, positions sizing etc… In essence we are attempting to build a rules-based, systematic imitation against which we can compare the actual decisions made by the fund manager. This could be as granular or simple as we wished.

The benefit of this more nuanced system is that it is not reliant on historic returns, but the philosophy and process of the manager. It can also provide a clear contrast between what a manager is doing in their fund, and what is happening in our model. The downside is that it requires the bespoke development of a stock picking / portfolio construction model, and is very reliant on how we might interpret the process adopted by a given fund manager.

Both of these approaches are imperfect and noisy, and provide nowhere near the confidence that we might take from an xG metric in football. We are, however, in an industry where discussions of skill are sorely lacking, and there is a heavy reliance on simple past performance with little attempt to separate luck and skill.

Creating some form of ‘expected alpha’ model for funds would have two primary benefits.

First, it would help form sensible expectations for a fund manager’s performance and allow us to focus on the divergence between that and reality. If our expected alpha model is struggling it is reasonable to expect the manager to be performing poorly. This moves us away from constantly obsessing over underperformance and outperformance versus a standard benchmark

Second, highlighting disparities between a fund manager’s results and a simple approximation of their approach could help to identify some form of skill or edge. Is there something happening that is distinct from what can be easily, systematically replicated? Is it worth paying for?

There is no magic bullet in assessing fund manager skill or edge, but the idea behind xG in football points towards a more nuanced means of looking beyond the luck and noise that dominates investing. Assessing fund managers through the lens of ‘expected alpha’ could help investors not only set reasonable performance expectations but better understand if value is being added and, if so, where it is coming from.

My first book has just been published! The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

The Four Questions Investors Must Ask

When we make an active investment decision, we obsess over the particulars of a given opportunity, whether it be a security, fund or asset class. This, however, distracts us from a far more important issue, which is so often ignored – should we be participating in the activity at all? This must always be our starting point. To make it so, we need to ask ourselves these questions:

– What are the odds of the game?

The critical first step is establishing the odds of the game we are playing. We want to engage in an investment activity where the odds are in our favour, or at least more in our favour than in other games. The major mistake we tend to make is grossly overstating our chances of success due to overconfidence in our abilities. To paraphrase Charlie Munger, who cares that 90% fail when I am in the 10% that succeeds?

The best means of guarding against such biased thinking is to assume that we are average. Rather than ask how likely is it that I will be successful, ask how likely is it that any given person will be (you never know, we might even be average ourselves). This approach gives us a reasonable base rate or starting point.

– Do I have an edge?

Once we have established a satisfactory estimate of the odds of success in an activity, we need to gauge whether we have an advantage relative to the average participant. If we are going to engage in a game with terrible odds, we are either ignorant of them, playing for fun (like a trip to Las Vegas) or believe there is something about our approach that puts us in the 10%. 

For professional investors, there is one additional reason that we might play a game with a low probability of success – because the cost of participating is borne by somebody else. The chance of positive (lucrative) outcomes for a fund manager are often significantly greater than it is for their clients.

The worse the odds, the more conviction we must have that we have some form of advantage. 

– What is the edge?

It is not enough to believe we have an edge; we must be clear about what it is and why it might exist. For most active investors, an advantage can be categorised as informational (we have better information than others), analytical (we use that information in a superior way to others) or behavioural (we exploit the decision-making shortcomings of others).

It is often argued that financial markets are more informationally efficient than ever before. There is more data, greater transparency and less friction. Making a case for an information-based advantage (in most major asset classes) seems a somewhat heroic assumption. Analytical edges are possible but incredibly difficult to substantiate. Where an analytical advantage arises, it is probably not from the ability to synthesise information better but to use it for a different purpose. Are we trying to predict next quarter’s EPS for a business or its long-run value?

Most market inefficiencies stem from the vagaries of human behaviour. It is difficult to argue that investor behaviour is becoming more rational, and certainly possible that things are getting worse. There is a problem with a purported behavioural edge, however. Not only do we have to contend that other investors are irrational, but that we are not. We are somehow free from the psychological and institutional burdens that lead to poor decisions. This is far easier to say than do.

– Who am I playing against?

In zero-sum games, the ability of the other participants matters a great deal. My chances of winning at poker heavily depend on who else is sitting at the table. Investing is similar but different.

It is undoubtedly true to say that having sophisticated, well-resourced investors facing off against each other is not a great environment to find an edge. Yet there is a major difference between poker and investing. In poker, everyone is playing with the same objective; in investing, this is not the case. Even though it feels like it. If I have a twenty-year investment horizon (if only) and other participants take a one-year view, we are barely playing the same game. At best, we are playing the same game with very different rules. So, the question becomes not – who am I playing against? But – what is it they are playing, and why am I able to do something different?

A painful confluence of compelling stories and inescapable overconfidence means that we are prone to participate in investment activities where the chances of positive results are very poor. To guard against this, we need to better understand the odds and justify why we might be an exception.  

My first book has just been published! The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

New Behavioural Investing Podcast – Decision Nerds

I am delighted to announce the launch of a new podcast, Decision Nerds. Paul Richards and I will be discussing a range of behavioural and decision-making problems with some fascinating guests. 

We know that there are a lot of podcasts out there, but there is nowhere near enough focus in the investment industry on how we can make better decisions in highly uncertain environments.

Our behaviour is the most important thing, yet we don’t talk about it anywhere near enough (apart from on this blog!)

We will be exploring a range of decision-making and behavioural issues with innovators, academics and industry specialists. 

In addition to these in-depth discussions, we will also be creating short episodes where we tackle listener questions and problems, and discuss the latest behavioural research. If you have an issue you would like us to cover, let me know!

In our first episode, we look at why investors can often be reticent to receive feedback on their decision making, with Clare Flynn Levy of Essentia Analytics. Clare founded a company with the express intention of helping investors become aware of their behaviour and improve it.

Put simply the quandary is this – to improve our decision-making, we need to clearly understand where we need to develop, admit that and then engage with a process that can help us. This sounds simple, but there are obvious risks as well as rewards. What if we find out we are not as good as we think we are, even worse, what if other people find out!?

Clare has been helping fund managers engage with these issues for many years, and shares some fascinating insights on the challenges around improvement and how they can be solved. There are some great thoughts and stories for anyone who wants to improve their investment decision making.

The pod is available on all your usual podcast platforms and also: here

Please leave a review and do let me know if there are topics you would like us to discuss in the future.

Why Don’t Fund Managers Talk About Skill?

In my career, I have spent hundreds of hours with fund managers attempting to assess their investment approach. When I look back at this, aside from questioning my life choices, the one thing that strikes me is how little fund managers discuss skill. Of course, they talk about past performance (if it is good), but the randomness and chance in financial markets render this a terrible proxy. This is a puzzling situation, investors in active funds are seeking to identify and pay for skill, but the people managing them seem reticent to mention it. 

It has always struck me as odd that in active fund selection, the onus falls heavily upon the allocator to strive to prove that the thing they are buying (skill) exists. Surely the seller of the product should be making that case?

Before exploring the reasons why investment skill is such a rarely discussed topic, it is worth defining terms. What exactly is skill?

Skill exists where we can see a repeatable link between process and outcomes (what we intend to do and the result of our action). We are often guilty of focusing on the second part of this equation – if the result is good, then some skill must be involved. This can be an effective shorthand if the activity is simple (shooting free throws in basketball) or heavily structured with limited randomness in the outcomes (playing chess). It is when things get noisy that the trouble starts.

In activities where the results combine luck and skill, focusing on outcomes alone can lead us astray. The greater the involvement of chance, the greater the need to understand the process that led to the outcome.

This is easier said than done. Focusing on process as much, if not more, than outcomes means retaining conviction and confidence even when headline performance is disappointing. Two things are critical here – time and belief. Extending our time horizon should tilt the balance in favour of skill over luck, but in order to have the required patience we must (continue to) believe that skill exists.

Imagine we have a biased coin that is likely to come up heads on 52% of flips. We should have more confidence in this edge becoming apparent the greater the sample size. To prove this advantage, we would rather see 10,000 flips than 10. We can think of this as akin to lengthening our time horizon. The problem is that if after 50 flips the coin has landed showing tails more often than heads, we might start to doubt that the coin is weighted at all.

Even if we possess an edge, we must often sit through periods when results make it look like we do not.

In investing, if skill exists, then it is difficult to identify and, if we do discover it, tough to benefit from. That does not mean we should ignore it. Asset managers are not only selling skill; they are paying people a great deal of money on the basis that they possess it. They should probably think about it more than they seem to.

Why don’t they?

Past performance is everything: The industry is obsessed with past performance, and it is so ingrained in how it functions that trying to have nuanced conversations about skill might be deemed to be pointless. Strategies with strong past performance sell; trying to evidence skill does not.  

Stories sell better: Evidence of skill, which might be about the consistency of decision-making through time, is far less compelling and persuasive than captivating stories about an investment theme or star fund manager.   

Time horizons are just too short: As time horizons in asset management seem to become ever-shorter, the relevance of skill diminishes. Nobody operates with a time horizon long enough to even attempt to prove they are skilful.

Too much complexity: Looking at past performance is easy, trying to define and evidence skill is complex and messy.

Don’t want to know: Let’s assume some active fund managers – but not many – have skill, 20%, perhaps. If I am one of the majority, it is in my interest to actively avoid the question of skill. My odds of a lucrative career are much better relying on random performance fluctuations and trends.

There are many reasons why the notion of skill is rarely discussed in the asset management industry, and all parties are complicit in its neglect. The existence and persistence of skill, however, is the foundation of active fund management and it needs to be talked about more.

If it is being sold, it helps to know what it is.

My first book has just been published! The Intelligent Fund Investor explores the beliefs and behaviours that lead investors astray, and shows how we can make better decisions. You can get a copy here (UK) or here (US).

What Can a Book Published in 1912 Teach Us About Investor Psychology?

A friend of mine recently asked if I had read a book called Psychology of the Stock Market. Given the subject matter, I was quite surprised that I hadn’t come across it. Even more surprising is that it was first published over 100 years ago. So, how do George Charles Selden’s thoughts on investor and market behaviour from 1912 compare with today? Has much changed?

Let’s look at some highlights:

“The market is always a contest between investors and speculators.”

Selden argues that there are two types of market participants. Investors – who are focused on the fundamental attributes of a security or asset, and speculators – who are concerned only with the direction of the price.

“The speculator cares nothing about interest return…He would as soon buy at the top of a big rise as at any other time.”

The idea that large swathes of investors have no real concern about the underlying value of a security is similar to something I wrote about valuation and price in 2022. He just got there a little earlier than me.

“However firm may be his bearish convictions, his nervous system eventually gives out under this continual pounding, and he covers everything…with a sigh of relief that his losses are no greater.”

Selden writes of a short seller who – despite retaining a stridently negative opinion – capitulates because of the pain of being the wrong side of a trade. Evoking not only loss aversion, but the emotional strain of being wrong.

“It is hard for the average man to oppose what appears to be the general drift of public opinion. In the stock market it is perhaps harder than elsewhere.”

We are inescapably drawn towards the behaviour of the crowd. Taking and maintaining contrary views can be exacting and exhausting.  

“the average man is an optimist regarding his own enterprises and a pessimist regarding those of others…he comes habitually to expect everyone else will be wrong, but is, as a rule, confident that his own analysis of the situation will prove correct.”

This description of overconfidence from Selden still resonates today. The odds and evidence are against everyone else successfully picking stocks, timing the market or making economic predictions – but, of course, I can do it.

“If you are long or short the market you are not an unprejudiced judge, and you will be greatly tempted to put such an interpretation upon current events as will coincide with your preconceived opinion.”

Confirmation bias remains as strong now as it was back in 1912.

“When the market looks weakest, when the news is at the worst, when bearish prognostications are most general, is the time to buy, as every school boy knows; but…it is almost impossible for him to get up the courage to plunge in and buy.”

Here Selden describes the difference between our behaviour in a hot and cold state. In our cool, calculating moments, it is easy to plan what we will do when markets are in turmoil; yet when that moment arrives our emotions will take hold with fear and anxiety overwhelming us. Selden was unknowingly advocating systematising future investment decision.

“It is a sort of automatic assumption of the human mind that present conditions will continue”

Extrapolation remains one of the most damaging investor behaviours.


“Some events cannot be discounted, even by the supposed omniscience of the great banking interests.”

Selden is writing of our inability to anticipate or price certain risks. Although we might think of this as similar to black swans, he goes on to mention earthquakes – so this is more about ‘known unknown’ tail risks, than events we have not even considered.  

Even the clearest mind and the most accurate information can result only in a balancing of probabilities, with the scale perhaps inclined to a greater or less degree in one direction or the other.”  

Selden alights on two vital topics for investors here. The need to think in probabilistic terms and the requirement to temper our confidence. Both are essential for dealing with such a complex system as financial markets. Humility is critical.

“The professional trader…eventually comes to base all his operations for short turns in the market not on the facts but what he believes the facts will cause others to do.”

Selden pre-empts the Keynesian beauty contest here and describes the behaviour of many investors then and now. Decisions are not made based on new information, but how it is perceived other investors will respond to that new information.

“Both the panic and the boom are eminently psychological phenomena.”

It is at the extremes of market behaviour that investor psychology is most apparent and difficult to resist.

“The “long pull” investor buying outright for cash and holding for a liberal profit, need only consider this matter enough to guard against becoming confused by the vagaries of public sentiment or by his own inverted reasoning.”

By “long pull” Selden is referring to long-term, fundamentally driven investor. To benefit from the long-term benefits of stock market investing one must ignore the fickle and forceful shifts in investor opinion and resist our own behavioural foibles. Easier said than done!   

“Another quality that makes for success in nearly every line of business is enthusiasm. For this you have absolutely no use in the stock market… Any emotion – enthusiasm, fear, anger, depression – will only cloud the intellect.”

It is difficult to overstate the extent to which our investment judgments are driven by how they make us feel. A good rule of thumb is – the stronger our emotion, the worse the decision.

“Sometimes it may become necessary to close all commitments and remain out of the market for a few days”

Selden is writing from a trader’s perspective here, so most of us can turn his “days” into weeks, months and years. The less we check our portfolios and watch financial news, the better our outcomes are likely to be.

Although Selden doesn’t use the same terms, it is impossible not to recognise the behaviours he describes. I am often asked whether an improved awareness of the pitfalls of investor psychology has improved behaviour. Unfortunately, I don’t think it has. Rather the ease of which we can trade, monitor our portfolios, and receive new information (noise) has made things worse. Selden’s words from 1912 are just as relevant today, if not more so. 


You can get a copy of Psychology of the Stock Market here.

I am not sure if my book – The Intelligent Fund Investor – will still be around in 100 years, so in case it isn’t you can get a copy now – here (UK) or here (US).