In his 2010 book entitled The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy, author James Montier states: “I…highlight some of the most destructive behavioral biases and common mental mistakes that I’ve seen professional investors make. I’ll teach you how to recognize these mental pitfalls while exploring the underlying psychology behind the mistake. Then I show you what you can do to try to protect your portfolio from their damaging influence on your returns.” Biases he surveys include: action bias, bias for stories, confirmation bias, conformity bias (herding or groupthink), conservatism (including sunk cost fallacy), disposition effect, empathy gap, endowment effect, hindsight bias, illusion of control, inattentional blindness, information overload, loss aversion, myopia, overconfidence, overoptimism, placebo effect, self-attribution bias and self-serving bias). Value investing provides the context for discussion. Citing a number of studies, he concludes that:
“…we should do our investment research when we are in a cold, rational state–and when nothing much is happening in markets–and then pre-commit to following our own analysis and prepared action steps.”
“…fear causes people to ignore bargains when they are available in the market… The ‘battle plan for reinvestment’ is a schedule of pre-commitments…”
“We should get used to asking ‘Must I believe this?’ rather than… ‘Can I believe this?'”
“…stop listening to the so-called experts.”
“All investors should devote themselves to understanding the nature of the business and its intrinsic worth…once you reject forecasting for the waste of time that it is, you will free up your time to concentrate on the things that really matter.”
“We would be far better off analyzing the five things we really need to know about an investment, rather than trying to know absolutely everything about everything concerned with [it].”
“Turning off the bubblevision is a great step towards preventing yourself from becoming a slave to the market.”
“…we need to learn to look for evidence that would prove our analysis wrong. …approach them with a blank slate. …play a game of devil’s advocate…”
“…what can we do to guard against the siren song of stories? …focus on the facts…”
“If markets seem too good to be true, they probably are. …remember this simple fact…”
“…to combat the pervasive problem of self-attribution we really need to keep a written record of the decisions we take and the reasons behind those decisions–an investment diary…”
“Patience is a weapon you can use to protect yourself from [action bias].”
“…have the courage to be different…be a critical thinker…stick to your principles.”
“Focusing upon process frees us up from worrying about aspects of investment which we really can’t control–such as return. By focusing on process we maximize our potential to generate good long-term returns.”
Some observations:
- James Montier’s emphasis is on how to keep behavioral biases from disrupting long-term value investing, not on how to exploit shorter-term emergent market behaviors that may derive from individual human biases.
- James Montier’s examples of “how some of the world’s best investors have striven to develop investment processes that minimize their behavioral errors” are incomplete in a research sense, arguably more story-like than research-like.
In summary, The Little Book of Behavioral Investing is a broad survey of behavioral biases and countermeasures as related to financial markets, especially for value investors. The self-awareness espoused may be as important to successful investing as valuation methods.
