My first book, The Intelligent Fund Investor, will be published by Harriman House on the 29th November 2022.
Fund investing is a fiendishly complex decision making problem. We are faced with a countless range of options and are constantly distracted by meaningless noise and turbulent markets. By asking fund investors to reconsider their beliefs and understand their behavioural biases, The Intelligent Fund Investor shows how we can make better investment decisions.
Each chapter explores a critical aspect of fund investing and provides specific steps on how to avoid the major pitfalls. Areas covered include:
– Why we should avoid star fund managers. – The dangers of funds with smooth returns. – How good stories make for terrible investments. – Why past performance is the worst possible basis for investing in a fund. – How the incentives of the asset management industry are often misaligned with its investors.
“Researchers in behavioural finance have spent decades cataloguing all manner of cognitive biases. For investors, and fund managers, that is only a starting point. Recognizing how these biases influence your behaviour, and sidestepping them, is the key to better investment decision making. Wiggins does this and more in his blog and new book The Intelligent Fund Investor.”
Tadas Viskanta, Founder and Editor of Abnormal Returns and Director of Investor Education at Ritholtz Wealth Management
“Joe’s observations about both portfolio manager and underlying investor behaviour are astute, important, and thought-provoking.”
Clare Flynn Levy, Founder and Chief Executive Officer of Essentia Analytics
“Joe’s continuous insights on behavioural finance and investor psychology lays the groundwork on ways investors can control their emotions and position themselves for success in investing. There is no doubt that professional and retail investors can learn, grow and become better long-term investors by reading Joe’s work.”
Justin Carbonneau, Partner Validea Capital and co-host Excess Returns Podcast
“One of the oft overlooked keys to successful investment is the ability to control the behavioural biases and weaknesses in decision making to which we are all vulnerable. Joe does an excellent job of explaining the challenges faced by investors and draws on his own experience as a professional investor to suggest ways of addressing these challenges. His writing is always engaging, insightful and grounded in the real world of investing.”
Dan Kemp, Global Chief Investment Officer at Morningstar Investment Management
“Joe writes with great clarity about the biggest obstacle to investors achieving their financial goals — their own behavior. His advice is suitable for individual and institutional investors alike and is in stark contrast to the efforts of most financial writing, which tries to predict a future that is inherently unknowable. “
Simon Hallett, former Chief Investment Officer at Harding Loevner, Chairman of Plymouth Argyle football club
“If you are looking for common sense, look no further than Joe Wiggins. A student of behavioural economics and human heuristics, his thoughts and observations are frequently amongst the most insightful, and useful, I read in markets today. Well worth your time.”
Nick Kirrage, co-head of the Global Value Team at Schroders
“A natural contrarian, keen to challenge the established wisdom of the crowd, Joe is a breath of fresh air to the manager selection community. Building on the foundations of his extensive manager selection experience for market leading investment firms, his behavioural research and insights can help both amateur and professional fund investors avoid becoming their own worst enemies in achieving their goals.”
James Millard, Chief Investment Officer at Hiscox
“Joe Wiggins is a fount of knowledge on behavioural finance and fund investing, and explains the subject in a thoroughly engaging way.”
Robin Powell, author of Invest Your Way to Financial Freedom
Bear markets are an inescapable feature of equity investing. They are also the greatest challenge that investors will face. This is not because of the (hopefully temporary) losses that will be suffered, but the poor choices we are liable to make during them. Bear markets change the decision-making dynamic entirely. In a bear market, smart long-term decisions often look foolish in the short-term; whereas in a bull market foolish long-term decisions often look smart in the short-term.
If we are to enjoy long-run investment success, we need to be able to navigate such exacting periods. There are certain features of bear markets that it pays to remember:
They are inevitable: Bear markets are an ingrained aspect of equity investing. We know that they will happen; we just cannot know when or why. That they occur should not be a surprise. The long-run return from owning equities would be significantly lower if it were not for bear markets.
It will feel predictable: As share prices fall, hindsight bias will run amok. It will seem obvious that this environment was coming – the warning signs were everywhere. We will blithely ignore all the other periods where red flags were abundant and no such market decline occurred.
We won’t call the bottom: Market timing is impossible, and this fact does not change during a bear market. The only difference is the attraction of attempting it when portfolio values are falling can become overwhelming, and the damage it inflicts will likely be greater than usual.
Economic and market news will be conflated: The temptation to interlace economic developments with the prospects for stock market returns can become irresistible during a bear market. Weak economic news will make us increasingly fearful about markets, despite this relationship being (at best) incredibly tenuous.
Our time horizons will contract: Bear markets induce panic, which means our time horizons shorten dramatically. We stop worrying about the value of our portfolio in thirty years and start thinking about the next thirty minutes. Being a long-term investor gets even more difficult during a bear market.
We won’t consider what a bear market really means: In the near-term, bear markets are about painful and worry-inducing portfolio losses, but what they really are is a repricing of the long-run cash flows generated by a business / the market. The underlying value of those businesses doesn’t change anywhere near as much as short-term market pricing does.
Lower prices are good for long-term savers: For younger investors saving for the long-term, lower market prices are attractive and beneficial to long-run outcomes (it just won’t feel like it).
Some losses won’t be temporary: For sensibly diversified, long-term investors the losses from most bear markets should be temporary (there is a long-run premium attached to equity investing after all), but we should not naively assume that everything will recover. Injudicious or ill-conceived investment decisions will be exposed in bear markets. Inappropriate leverage, unnecessary concentration and eye-watering valuations tend to bring about permanent losses of capital that time will not heal.
Emotions will dominate: Our ability to make good, long-term decisions during a bear market is severely compromised. Rational thought will be overcome by the emotional strains we are likely to feel – what happens if things keep getting worse and I didn’t do anything about it? It is during such times that systematic decision making – such as rebalancing and regular saving – come to the fore.
Our risk tolerance will be examined: Bear markets are the worst possible time to find out about our tolerance for risk. Everyone becomes risk averse when they are losing money. The problem for investors is that living through a 37% loss is a far different proposition to seeing it presented as a hypothetical scenario. If possible, we should avoid reassessing our appetite for risk during tough periods.
We will extrapolate: During a bear market, it is hard to see anything ahead but unremitting negativity. Our tendency will be to believe that things will keep getting worse – prices will be lower again tomorrow.
Each bear market will be different: We should ignore all charts comparing current declines with other bear markets in history, they are entirely unhelpful. There is no reason to believe that such a deeply complex, unpredictable system should mimic patterns of the past. Each bear market is unhappy in its own way.
Bear markets are the ultimate behavioural test: The outcomes of bear markets are more about us than they are about the market. Investors entering a bear market with identical portfolios will have wildly different results based on the decisions that they make during it.
Equity bear markets make all the usual challenges of being a long-term investor that much more difficult. The noise of daily market fluctuations will become deafening, we will check our portfolios even more frequently and may find the urge to make short-term trades irresistible.
Everyone has an investment plan until they experience a bear market.
Last week I stumbled upon an old Grantland article by David Hill titled: “Can’t Knock the Hustle”. [i] It is a fascinating examination of the two faces of competitive pool in the US. On one side was the traditional approach of conventional tournaments with prize money awarded to the winners (think the PGA Tour), on the other was ‘action rooms’ where the purpose of the pool matches was gambling – spectators and players would bet on the outcomes of all manner of games with a variety of handicaps applied. Although it is the same game being played, the objectives are entirely different – in one it is to find the best player, in the other to find the best odds. This distinction is important for investors. We spend much of our time trying to find the best investor, company, fund or story, and not enough time thinking about the odds.
The focus of the article was two characters. Earl ‘the Pearl’ Strickland – one of the most successful and controversial players in history (he has won over fifty major titles) – and ‘Scooter’ Goodman, a player focused on gambling and action rooms.
Although Goodman was a pool player, this wasn’t his primary skill:
“Goodman has a knack for figuring out complex odds and probabilities”.
His main enjoyment from pool was not the game itself, but in attempting to secure an advantage in agreeing the terms of the game. His edge was not in shooting pool but setting the odds in his favour.
“That’s my favourite part, the negotiating…This is where you win.”
Critically, Goodman understood that he did not need to be a great player like Strickland, he wasn’t interested in winning tournaments or climbing rankings. He just had to understand how good he was relative to the competition.
“I can play the best in the world up here if you give me enough weight”.
By “weight”, Goodman means advantages or impediments that impact the odds. This might be one player giving up all the breaks (a major impairment) or the weaker player having to pot fewer balls to win the rack. There is all manner of adjustments that can be made to transform the probabilities of the game.
While Goodman thought about little but the odds of success, as investors we are prone to neglect them. This leaves us incredibly vulnerable to making decisions where the chance of a good outcome is vanishingly small.
Against the Odds
Why don’t investors like thinking in terms of odds? There are two reasons – because its less exciting than the alternative, which is largely storytelling, and because it is perceived as too difficult.
Identifying a star fund manager, ten-bagger stock or the next great investment theme is far more captivating than trying to make a realistic assessment of the odds of success in that type of activity (particularly when the odds are usually terrible). When we have a compelling, narrative-led inside view, its salience means we grant it far more importance in our judgement than we should.
Calculating odds also feels like an inherently complex or even impossible task, but this is not the case. We don’t need to be spuriously accurate about the likelihood of a good outcome, just a general guide can be incredibly insightful.
When making an investment decision, we should think about the odds of positive outcomes in two ways:
1) What are the base rates for this type of decision? This means forgetting the specifics of a situation but looking at the outcomes of a reference class of similar instances.
Let’s take an example. In 2021, Jeffrey Ptak at Morningstar wrote a timely piece looking at the subsequent performance of funds after they had returned more than 100% in a calendar year.[ii] The results were bleak – of the 123 funds that had achieved this feat since 1990, 80% went on to register losses in the three years that followed.
This type of analysis is about creating a base rate to provide us with an outside view on a decision. When looking at a fund that has produced stratospheric returns it is very easy to be beguiled by the inevitably compelling stories that will be told about the theme and its manager. This can leave us entirely blind to the odds we are likely to be facing.
There is no right answer on base rates, no single metric that will provide precise and accurate odds but taking this type of outside view should be integral to any investment decision.
2) How difficult is the game we are playing? We should also spend time reflecting on the difficulty of the task we are undertaking. Imagine we are trying to forecast where ten-year treasury yields will be at the end of the year. We can carry out forensic analysis of inflation dynamics and Fed policy, but before beginning this process we should be asking – how likely is it that we are going to get the answer to such a complex question right?
Overconfidence leads us to involve ourselves in investment activities where the sheer difficulty of the activity means that a successful result is very unlikely.
Thinking about odds and probabilities is not intuitive and often uncomfortable, but it should be essential for all investors. It is far better to be an average investor with the odds on our side, than a good investor with the odds stacked against us.
Although I am clearly partial to a blog post and enjoy a good tweet or thread, few things can beat reading a great book. The beauty of a book is not just the depth in which a topic can be explored but the focus it necessitates – the physical act of buying and reading one can act as a commitment device, encouraging us to learn something new or think about something differently. Books do not make us immune to the enticement of other attractions competing for our attention, but they can add a healthy element of friction between us and the next shiny object.
I often get asked which books an investor keen to learn more about behaviour should read, and almost certainly give wildly inconsistent answers. To rectify that, here is a list of some of the books that have most influenced my thinking and are also brilliant reads. The majority of those listed are not explicitly related to behavioural finance, but they are all about how and why we make the decisions we do:
Annie Duke – ‘Thinking in Bets’: A fantastic book which not only extols the virtues of probabilistic thinking but manages to do so in an engaging and captivating fashion.
Jeffrey A. Friedman – ‘War and Chance’: Something of a hidden gem, ‘War and Chance’ is a fascinating study of decision making under conditions of uncertainty through the lens of international politics. Particularly insightful around why people are reluctant to talk in probabilistic terms.
Tren Griffin – ‘Charlie Munger – The Complete Investor’: Nobody speaks more lucidly on investor behaviour than Charlie Munger, and Griffin does an excellent job of distilling his wisdom. Those short on time should read Munger’s speech: “The Psychology of Human Misjudgement”, which is probably the single best piece of work on investor behaviour.
James Montier – ‘Behavioural Investing’: If my unreliable memory serves me correctly it was James Montier’s forthright and humorous writing on the vagaries and inconsistencies of investor behaviour that really got me engaged in the subject. This book is hard to get and expensive, but Montier has a ‘Little Book’ version, which incorporates some of the insight and ideas of its larger sibling.
Daniel Crosby – ‘The Behavioral Investor’: Not only does Crosby’s book provide a great overview of how behavioural concepts interact with our investment decisions, but he also offers practical ideas about dealing with our most damaging foibles.
Daniel Kahneman – ‘Thinking Fast and Slow’: Just in case this hasn’t been read by everyone, it is worth highlighting the book that became the foundation stone for the burgeoning interest in behavioural science. No, not every study cited replicates; but yes, it is a great introduction to human behaviour and the choices we make.
Gerd Gigerenzer – ‘Risk Savvy: How to Make Good Decisions’: Gigerenzer’s work is incredibly underrated. His focus on the effectiveness of simple heuristics and decision rules to navigate complex systems is essential for investors who are constantly faced with a volatile and unpredictable environment.
Peter Bernstein – ‘Against the Gods – The Remarkable Story of Risk’: Achieves the extraordinary feat of explaining the history of risk – from Greek mythology to portfolio insurance – in an entirely fluent and engaging manner.
Nassim Nicholas Taleb – ‘Black Swan – The Impact of the Highly Improbable’: Although the term ‘black swan’ is now widely misused, Taleb – in his own inimitable style – covers the folly of predictions, the dangers of models and the often-neglected impact of extreme events. Essential lessons for any investor.
Michael Mauboussin – “The Success Equation: Untangling Skill and Luck in Business, Sports and Investing”: No investment writer has a higher signal to noise ratio than Michael Mauboussin, his hit rate for producing distinctive and rigorous work is unsurpassed. “The Success Equation” is particularly important for investors because one of our primary failings is our inability to distinguish between luck and skill – a consistent and costly mistake.
Will Storr – ‘The Science of Storytelling’: Not obviously about investing or behaviour, Storr’s book looks at humanity’s fascination with stories and how and why they have such a profound impact on us. It is hard to think of any investment behaviour that doesn’t have a story at its heart, which makes understanding narratives essential to understanding our decisions.
Rory Sutherland – ‘Alchemy’: Aside from being very funny, Sutherland’s book challenges conventional wisdom about our behaviour and encourages counter-intuitive thinking.
Robert Cialdini – ‘Influence’: A timeless psychology book. As investors we are always being influenced or trying to influence others. Cialdini breaks this process down into six critical principles.
Morgan Housel – ‘The Psychology of Money’: The beauty of Housel’s wildly successful book is its coupling of vivid storytelling with broad appeal. It is a book about our relationship with money but it’s not for investors, it’s for everyone.
I have inevitably missed some personal favourites that weren’t in my mind at the time of writing and there are also those which, tantalizingly, I have not yet discovered!