I’ve written many articles on the rational analysis of a stock’s financial fundamentals, whether it be free cash flow, payout ratio, earnings growth, or business-like value investing. But the stock market is run by humans, not computers, so all the rational analysis in the world won’t guarantee that you will make any money over the short-term.
Emotion is an Investor’s Enemy
For long-term investors, waiting a substantial period of time for the marketplace to turn rational would work out fine in the end, but all too often even self-proclaimed “long-term” investors get influenced by the short-term passions of the stock market and abandon their value-based investment approach to chase emotional trends just in time for the emotions to run their course and then reverse. Getting whipsawed through frequent emotional trading is a sure-fire way to financial ruin.
No doubt about it, investing in the stock market can be maddening. Understanding human emotion – both the irrational forces that influence the market as a whole and one’s own emotional weaknesses – is just as important if not more important to successful investing than numbers-based financial analysis.
The study of human emotion in financial markets – formally known as “behavioral finance” — has been around since the 1970s, but for a long time it remained the exclusive province of academics like Daniel Kahneman, Amos Tversky, Richard Thaler, and Robert Shiller. Over the past decade, however, the study of behavioral finance has become a mainstay of investment professionals as well.
One of its strongest adherents today among practitioners is a man named James Montier, author of many books on the subject, the latest being The Little Book of Behavioral Investing: How Not to be Your own Worst Enemy. Until recently, he also had a behavior finance blog. I’ve followed Mr. Montier for many years ever since he worked on the global investment strategy team at Dresdner Kleinwort Wasserstein in
10 Rules of Happiness
For me, he really became famous in 2004 after writing an incredibly unconventional piece – for financial advisors anyway — on happiness. How many investment advisors do you know that provide their clients with the following advice:1. Don’t equate happiness with money.
- People adapt to income shifts relatively quickly, the long lasting benefits are essentially zero.
2. Exercise regularly.
- Taking regular exercise generates further energy and stimulates the mind and the body.
3. Have sex (preferably with someone you love).
- Sex is consistently rated as amongst the highest generators of happiness. So what are you waiting for?
- Close relationships require work and effort, but pay vast rewards in terms of happiness.
- Simple reflection on the good aspects of life helps prevent hedonic adaptation.
- It makes sense to do something you enjoy. This in turn is likely to allow you to flourish at your job, creating a pleasant feedback loop.
- Faulty perceptions of what makes you happy, may lead to the wrong pursuits. Additionally, activities may become a means to an end, rather than something to be enjoyed, defeating the purpose in the first place.
10. Remember to follow all the rules.
Wow. This is deep philosophical stuff and I believe it would be well worth it for each and every one of us to spend some time over the weekend pondering these ten rules of happiness. I know that I don’t currently follow all of these rules and would definitely benefit from adhering more closely to them. Montier himself would probably admit that he doesn’t adhere to all of them. Anyway, they’re something to strive for. I searched the entire InvestingDaily.com website for the word “happiness” and it didn’t come up once. After today, that will no longer be the case.
We sometimes forget that investing is a means to an end and not an end in itself. The means is making money, but the end is freedom and security for ourselves and our families. If life has any meaning, happiness is it, so I plan to take the concept of happiness more into account in my future writings. To get started, this weekend I’m going to take Woody Allen’s advice in the 1986 movie Hannah and Her Sisters and rent the 1933 movie Duck Soup by the Marx Brothers.
7 Rules of Investing
What got me thinking about Mr. Montier today was a more conventional article he has written at his newest employer, the Boston-based investment firm Grantham, Mayo, Van Otterloo (GMO). It’s called The Seven Immutable Laws of Investing and focuses on eliminating behavioral biases that can impede our accumulation of wealth.
I discussed my take on Montier’s seven rules of investing here.