Crosby, Daniel – The Behavioral Investor

Harriman House, 2018 [Finance] Grade 4

Read as pdf… Link to Amazon…

This is a book with great ambitions. In the first sentence Daniel Crosby says that the aim for The Behavioral Investor is to be the most comprehensive guide to the psychology of asset management ever written. Dr. Crosby, a psychologist by training, is the Chief Behavioral Officer at Brinker Capital and a leading blogger and podcaster on the subject of behavioral finance – this is his forth book on different topics in this discipline.

Some fifteen years ago I fell in love with behavioral finance as it so obviously described aspects of investing and financial markets that traditional finance and economics didn’t. Over time the interest has however started to wane since the academics in the area devoted their energy towards adding yet another insult towards the previously dominant efficient market hypothesis creating an ever growing list of interesting and quirky behavioral biases but no real practical applications for investors. According to the author “[…] all this ends today, as we will take [these biases] and speak to the particulars of what they mean in the context of making money.” I would argue that the aim of being the most comprehensive guide is reasonably well met for a book of “only” about 250 pages. With regards to fulfilling my wish of an applied behavioral finance investment method The Behavioral Investor unfortunately only gives fairly broad guidelines.

The author is well read in both academic literature and more practical investing books. Despite the author’s learnedness the language is very readable and clear as Crosby’s writing comes with a humorous and personal touch. This is a finance book without most of the technical finance jargon – although at times it instead contains some psychology terminology. Nevertheless, it’s undoubtedly a very readable book.

The book is structured in four parts with the first outlining the sociological, neurological and physiological foundations to the biases investors exhibit. Then the author summarizes the many documented psychotically based follies of investors into four primary tendencies regarding ego, conservatism, attention and emotion. Part three tries to list practical measures to overcome the previously described problems and finally the book ends with the author’s “third way” of investing (as opposed to passive investing and active investing) called rules-based behavioral investing (RBI). Hence, the first half gives a background and the second half tries to apply the learnings in real life. Throughout The Behavioral Investor Crosby discusses most of all the psychological experiments and subsequent findings that a frequent reader of behavioral finance literature will ever have heard of but without it ever getting tedious.

RBI is as the name suggests rules based with a high base allocation to equities implemented through a combination of value and momentum quant based equity portfolios and with an overlay of valuation (Tobin’s Q, CAPE etc.) and momentum (200-day or 10 month moving averages etc.) based rules for when to very occasionally lower the allocation of equities. The focus is to find a rational and evidence based methodology where the room for behavioral biases is kept to a minimum. Although this is only one of several good ways to manage money I personally think this is a great setup, but regrettably Cosby only gives a very fleeting description of what his RBI actually looks like. Further, the Achilles heal of the rational quantitative strategy is that it needs permanent money or else it will suffer redemptions at the exact wrong moment from its less than rational human investors.

If this is one of the first books you read on behavioral finance you are to be congratulated as it will surely be mind-blowing. If you have followed the area during its development, The Behavioral Investor is a very good inventory of current knowledge but it adds relatively little new. And perhaps it’s a good thing that a best selling book cannot deliver a detailed best practice behavioral finance investing method as it is then up to me to develop it myself.

Mats Larsson, December 31, 2018

Duke, Annie – Thinking in Bets

Prentice Hall Press, 2018, [Behavioral Finance] Grade 4

Read as pdf… Link to Amazon…

If you were to analyze poker, it’s basically a game of decision making under uncertainty. Should I call? Raise? Go all in? Or maybe fold? The only thing you know for sure is the hand you are dealt. The uncertainty lies in everything else.

Poker is about making the right decisions when you don’t have all the information available. When looking at the stock markets it’s not hard to spot the similarities. The market is just a big pile of uncertainty with you stuck in the middle trying to make money.

Internet poker was a big thing when I grew up, and my enthusiasm for the sport (if it is one?) has indeed served me well. I stumbled across Annie Duke when she was interviewed on The Capital Allocators Podcast. When I heard that she was writing a book about how to approach life as a betting game, I was already sold.

This is a book about decision strategy, and Annie is a very experienced decision strategist. Even if the book is filled with anecdotes from Annie’s poker career this is far from a poker book. Instead it’s a book about making good decisions when you can’t see all the cards, both figuratively and literally. It turns out, this is a situation we find ourselves in almost all the time. When we decide to go to the movies we’re taking a bet on that the movie will be a better experience than staying home. When we order meat at a restaurant it’s a bet that it will prove a better experience than the fish. Every decision is a bet on something - we are just not used to think about decisions this way.

Duke suggests that by analyzing our decision process we can subsequently use tools that makes it easier activate system 2 (it’s time to read Daniel Kahneman’s Thinking, Fast and Slow if you for some unexplainable reason haven’t already) and think more rationally.

One interesting example of this is one about actual betting. Most people are in the habit of making statements as if they were always true. We often accept these at face value since it instinctively seems at least moderately accurate. If we instead reply with “Wanna bet?”, the mindset shifts dramatically. Now we try to think hard if the said statement is maybe 70% or 100% true. The difference is of course enormous, but without forcing ourselves to make a bet, we take mental shortcuts and jump right to the, often wrong, conclusion. By trying to ask ourselves if we would place a bet on something, we can help ourselves along the path to Kahneman’s famous system 2.

Another very helpful idea that the author taught me was the idea of setting up decision groups whose only task is to analyze and evaluate each other’s decisions. The group is in itself an interesting concept, but what its mere existence does to you is far more interesting. Before deciding, try to foresee what your decision group will make of it. What objections might they have? Which questions will they ask? What will they think about your decision? Will they approve of your action or will you walk away embarrassed? By anticipating the decision-group’s feedback before you even make up your mind in the first place, you are far more likely to make a rational decision based on facts and not gut feeling alone. You don’t even have to go to the group, as long as the group’s pressure affects your decisions.

If you’ve read a book or two on behavioral finance you will certainly feel at home with Thinking in Bets. It takes all the common concepts and tries to find a more practical approach to beating biases and poor decision-making. This is a great book for anyone; buy it for Christmas for everyone you know. It is not an investing book; it’s a book about not being a dumbass. Which for sure is a goal I have as an investor.

Olle Qvarnström, November 29, 2018

Zweig, Jason - Your Money & Your Brain

Simon & Schuster Paperbacks, 2007, [Behavioral Finance] Grade 5

Read as pdf... Link to Amazon...

“The investor's chief problem – and even his worst enemy – is likely to be himself.” Many of the readers are probably familiar with this profound quote from Benjamin Graham in the Intelligent Investor. In Your Money & Your Brain, Jason Zweig presents many of the reasons to why the sentence by Benjamin Graham is true. The book is aimed at helping the reader to profit for the long term both in terms of wealth and also living a more meaningful life by understanding the psychological reasons for our actions.

Zweig has been working as a financial journalist for more than 30 years. More than the last 20 years have been spent with the Wall Street Journal where he has been writing weekly columns. His columns are most often focused on subjects such as financial history, behavioral finance and neuroeconomics. Zweig is passionate about helping people to avoid bad investment decisions which includes criticizing bad practices in the financial market.

For value investors Zweig is probably most known for having updated the latest edition of the Intelligent Investor. The author describes how his interest for neuroeconomics started in 1998 when he picked up a newspaper at an airport which included an article about neuroscience. The subject led Zweig to insights he couldn't have dreamed of acquiring simply by reading typical investment material highlighting the importance of learning from multiple disciplines.

Your Money & Your Brain can be used as a source to gain understanding about why humans react as they do and why. The human brain is ancient and is still optimized for the hunter gatherer society where humans have spent most of their existence. Many readers may be aware of some of the concepts in the book, having already read books such as Daniel Kahneman's Thinking Fast and Slow.

The book starts with an introduction to neuroeconomics and how the brain works. The reader is then presented with areas and feelings that have huge impact on investors and other decision makers. Some of these are fear, greed, confidence and regret. In every chapter, Zweig describes the neurological background to the feelings and also presents recommendations on how to live and act as an investor in order to avoid them. He presents which part of the brain is causing which feeling and introduces the reader to further studies about the brain. He backs up all the material with references to scientific studies.

Both this book and Zweig's The little book about safe markets, published in 2010, is directed to a broad mass of people and to personal finance readers, making some of the material a bit basic for the experienced investor. The benefit of this is that the language is really easy to grasp. Zweig is a terrific writer in how he is making a difficult topic feel simple.

Having read a lot of books about behavioral economics and neuroeconomics I have gotten the impression that the most important thing is to set up habits and routines to avoid ending up in certain situations, instead of trying to overcome them. That impression only got stronger having read this book. Zweig steer his readers in a very clever way as he is ending every chapter with suggestions of habits that could help the reader avoid getting tricked.

Myself, I have already started to introduce some of the habits in my daily life which I see as a great compliment to the author. As many other investors, I have felt the pain of having fooled myself and am working hard to avoid it. Your Money & Your Brain is of great aid in that regard.  

Niklas Sävås, January 31, 2018

Rosenzweig, Philip - The Halo Effect

Free Press, 2014, [Behavioural Finance] Grade 4

Read as pdf... Link to Amazon...

The Halo Effect is something as paradoxical as a business book about how bad business books are. The main objection is that while most management books describe their formulas for success as the result of scientific study they are in fact often just pseudoscience combined with good storytelling. The author, Philip Rosenzweig, has written several books on business performance and behavioural finance. After earning a PhD at Wharton he spent six years at Harvard Business School. He is now a professor of strategy and international business at IMD in Switzerland.

The key premise is that it is hard to know why one company is a success and another is a failure. It is therefore difficult to distil a simple formula for success, as so many management books try to do. An important business delusion that Rosenzweig discusses is the halo effect. It means that a company’s performance creates a halo that affects how the company is perceived. The story of Percy Barnevik and ABB is given as an example. When profits tripled between the years 1988-1996 Barnevik was described by the business press as brilliant, hardworking and humble. A part of the success was also attributed to ABB’s unique organizational structure that made the company action orientated and nimble. But when ABB’s fortunes turned in the early 2000s and profits declined the story changed significantly. Suddenly Barnevik was arrogant, imperial, and resistant to criticism. The organizational structure which was previously a key success factor was now labeled as chaotic and a reason for the company’s problems.

Hence, Rosenzweig argues that there are no simple answers to the question: What leads to high performance? According to him company performance is the result of strategic choices and execution. But there is no simple generic formula that works for all companies and situations.

The book starts with describing the challenges of studying company performance objectively. After some real-world examples, the author describes 9 different delusions when it comes to understanding business performance, focusing on the halo effect. Rosenzweig ends the book with some proposed solutions to the described challenges. The book is a quick, easy and enjoyable read.

The ideas covered in the book are important and I agree with Rosenzweig in his critique against most management books and how business performance is analyzed. Companies that have had recent financial success are often assigned positive and maybe even unique attributes. In a way the book deals with physics envy. Business and management are not exact sciences like physics and should not be treated as such. There are no exact formulas that will tell you how to achieve success. As a manager and investor, you need to be able to handle uncertainty and change. This book is a great reminder of that.

That said, I think the book is a bit unbalanced in terms of how it is structured. Rosenzweig spends the majority of the book discussing the halo effect and criticizing two management gurus and their books. Although those gurus are famous, the majority of authors, journalists and analysts are subject to similar cognitive biases. I would have liked the book to be broader in terms of discussing different pitfalls in analyzing business performance instead of just focusing on the halo effect and the three mentioned books.

Although the book is mainly written for managers, the described delusions are important to keep in mind for investors as well. For example, it is sometimes tempting to assign a competitive advantage, a superior culture or excellent management to a company that happens to be on a good performance streak. The lessons from this book might prevent that mistake. 

So, if you enjoy reading management books or analyzing businesses, the sooner you read The Halo Effect, the better.

Mikael Tarnawski-Berlin, January 11, 2018

Cialdini, Robert B. - Influcence: The Psychology of Persuation

Harper Business Revised Edition, 2006, [Behavioral Finance] Grade 4

Read as pdf... Link to Amazon...

As an investor, it is essential to make rational decisions and at all times choose the alternative where the value is highest compared with price. Psychological biases often distort this thinking, causing investors to make irrational decisions. In this legendary book from 1984, Dr. Robert Cialdini, one of the most influential persons in the field of marketing psychology presents the most important influences on decision making and provides examples where it leads to irrational behavior.

An interesting fact with the book is that Cialdini mainly wrote it to help people to become aware of the tricks that are used by salespeople. Ironically the same salespeople started to use the examples to their benefit. Cialdini describes his interest in the subject similarly to Charlie Munger, they don't want to be fooled or as Munger describes it "be a one-legged man in an ass kicking contest". I don't want to be a fool either and that's one of the main reasons why I chose to read this book. I want to learn more about situations where influences of psychology are strong in order to improve my decision making in life and as an investor.

Cialdini describes situations where animals react to stimuli in certain ways and how humans have inherited a similar pattern of behavior. Automatic behavior is often, but not always, the most efficient form of behaving. The psychological influences presented in the book are: social proof, reciprocity, commitment & consistency, authority, liking and scarcity. These influences are normally the most reliable in helping us to make correct decisions but for the same reason therefore often used to trick us. They are also increased by stress and fatigue, causing them to be amplified by the tempo of the modern world.

What's great with the book are all the powerful real-world events that are presented next to the scientific evidence. Cialdini brings up fascinating examples where the influences described have caused unbelievable situations as when 39 people witnessed a murder without anyone calling the police and when 910 people committed suicide in the jungle of Guyana, both by the impact of social proof. Another fascinating example is the Milgram experiment where students sent supposedly deadly electrical shocks to test persons under the influence of authority.

The structure of the book is really easy to follow and even though the main influences are presented one by one instead of in combinations, which might have been a more logical way, the author succeeds in weaving them together. The focus is not on the investment area but it's unavoidable to draw parallels to such factors as confirmation bias, loss aversion and herding among others and thus get an explanation to why these biases are so powerful.

This is a fascinating book and an eye-opener for those who haven't yet realized the power of psychology and how it impacts behavior and decision making. The influence of the book is confirmed by the many devoted practitioners in sales and marketing making use of the examples provided. By knowing about the effects that the psychological influences lead to, they can be tackled, which is the key takeaway of this book.

Niklas Sävås, November 6, 2017

Neill, Humphrey B. - The Art of Contrary Thinking

Caxton Press, 2007 (first ed. 1954), [Behavioural Finance] Grade 3

This is one of the few general books on contrary thinking that exists. More specifically, there are gazillion publications on value investing but only a handful on contrarian investing. This book is built on a pamphlet and a collection of essays from the 1940s and 1950s. Humphrey Neill was a... Further reading... Link to Amazon...

Howard, C. Thomas - Behavioral Portfolio Management

Harriman House, 2014, [Behavioural Finance] Grade 4

This is a book on how to exploit the irrationality of financial markets. Thomas Howard is the Denver University finance professor that converted from Modern Portfolio Theory (MPT) to Behavioral Finance and turned practitioner by founding AthenaInvest where he as the CIO... Further reading...  Link to Harriman House...  Link to Amazon...

Dobelli, Rolf - The Art of Thinking Clearly

HarperCollins Publishers, 2013, [Behavioural Finance] Grade 3

We don’t know what makes for a successful investor or the key to happiness, however we do know what does not. In the words of Warren Buffett: “Charlie and I have not learned how to solve difficult business problems. What we have learned is to avoid them”. The method of illuminating...  Further reading...  Link to Amazon...

Smith, Adam - The Money Game

Vintage Books, 1976 1st ed, [Behavioural Finance] Grade 5

Long before the term behavioural finance there was someone writing about the significance of identity. Long before the witty Buffett-isms, someone wrote those same words as part of his Irregular Rules. And long before Michael Lewis carved out his own position as the...  Further reading...  Link to Amazon...

Fisher, Ken - The Little Book of Market Myths

Wiley, 2013, [Behavioural Finance] Grade 4

The Little Book series is now 28 books old and has set out to prove all those early doubters wrong, simply by taking the difficult & complex out of financial matters. It doesn’t hurt, of course, to also have contributors such as Joel Greenblatt, John Bogle and Mark Mobius, to name just a few of...  Further reading...  Link to Amazon...

Taleb, Nassim Nicholas - The Black Swan

Random House, 2007, [Behavioural Finance] Grade 5

To call this book an investment classic is an understatement. The Black Swan has had a huge impact also beyond the enclosed world of finance. A Black Swan is today a part of everyday vocabulary. Former trader and now author/ philosopher Nassim Taleb wasn’t first to...  Further reading...  Link to Amazon...

Mehta, Ravee – The Emotionally Intelligent Investor

LES Publishing, 2012, [Behavioural Finance] Grade 4

After reading the first chapters I thought “oh no, it’s just another book listing behavioural biases”. It’s not. This book combines two related genres, down to earth trading psychology books and the more academic texts on behavioural finance. On top, a good sprinkle of the authors and his...  Further reading...  Link to Amazon...

Taleb, Nassim Nicholas – Antifragile

Random House, 2012, [Behavioural Finance] Grade 3

Not many authors are as fearless and eloquent advocates of their views. That makes Nassim Taleb a thought-provoking author. Taleb regards himself as both a trader and philosopher. He is a household name in the investing world and was propelled into fame with his two books Black...  Further reading...  Link to Amazon...

Kahneman, Daniel – Thinking fast and slow

Farrar, Straus & Giroux, 2011, [Behavioural Finance] Grade 4

The author of this book won The Nobel Memorial Prize in Economic Sciences in 2002 for his prospect theory. However this book was written after that with the prospect of getting him a wider audience. He was very sceptical of whether he was going to be successful with this or not...  Further reading...  Link to Amazon...

Keynes, John Maynard – The General Theory of Employment, Interest, and Money (Chapter 12. The State of Long-Term Expectation)

Prometheus Books, 1936, [Behavioural Finance] Grade 5

This is not a review of the book that many argue is that cradle of modern macroeconomics. Instead it is a peak into the brilliant mind of J.M. Keynes the investor. One, by economists mostly forgotten, chapter of Keynes magnum opus is fully devoted to investing - and what a chapter...  Further reading...  Link to Amazon...

Tuckett, David – Minding the Markets

Palgrave, 2012, [Behavioural Finance] Grade 4

Fifty-two portfolio managers placed on a shrink’s couch, can that make a useful book? It sure can. Award winning psychoanalyst David Tuckett has an initial training as an economist which creates an unusual and fortunate cross pollination of knowledge. While finance and psychology...  Further reading...  Link to Amazon...

Koppel, Robert – Investing and the Irrational Mind

McGraw-Hill, 2011, [Behavioural Finance] Grade 4

A system with a proven edge and good money management practices are necessary but not sufficient for someone to succeed in trading. The decisive factor is the trader’s psychological fortitude. Robert Koppel is a former commodities trader and hedge fund partner who has...  Further reading...  Link to Amazon...

Taleb, Nassim Nicholas - Fooled By Randomness

Texere, 2001, [Behavioural Finance] Grade 5

The book is written by the previously unknown trader Nassim Nicholas Taleb who with this became instantly famous. He brings the concept of the black swan to life, which now forever will be associated with him. In his second book, The Black Swan, the impact of the highly improbable, he digs further into...  Further reading...  Link to Amazon...

Montier, James - Value Investing

John Wiley & Sons, 2009, [Behavioural Finance] Grade 5

James Montier is a former sellside strategist, author of several books, currently working at GMO, a privately held investment management firm. He still writes insightful material under GMO Insights, together with other very readable persons like Edward Chancellor and Jeremy Grantham. The book comes with...  Further reading...  Link to Amazon...

Mauboussin, Michael J. - Think Twice

Harvard Business Press, 2008, [Behavioural Finance] Grade 5

The Autobahn to buying low and selling high is cluttered by mental traps, institutional barriers and questionable theories (CAPM, anyone?). This core read by Mauboussin deals with the first and arguably most important of those...  Further reading...  Link to Amazon...