Investors are their own worst enemy. This 700 page book shows how mental biases cause most investors to perform badly, and offers remedies. It is very clearly written and easy to read. I recommend it to all experienced investors.
19 March 2016
Almost exactly one year ago I read and wrote a review of "The Little Book of Behavioral Investing: How Not to be Your Own Worst Enemy" by the same author. However, I had forgotten that when I ordered and then read this book!
Last August while reading another book on investment I saw several references to this book. Despite its cost and size, 706 pages, I bought and read it because managing my investments is important to me and I am acutely conscious of the mistakes which I have made over the years.
It reminds me of the anecdote that when it comes to car safety, the most dangerous component in a car is the nut behind the steering wheel, namely the driver.
The book was published in 2007. It consists of a large number of relatively short articles published in the preceding five or so years in “Global Equity Strategy” which are stated to be copyright Dresdner Kleinwort.
At the time the book was published, James Montier was Global Strategist at Société Générale. He is currently with GMO LLC which describes itself as “a private partnership whose sole business is investment management.” His biography on their website states:
"Mr. Montier is a member of GMO’s Asset Allocation team. Prior to joining GMO in 2009, he was co-head of Global Strategy at Société Générale. Mr. Montier is the author of several books including "Behavioural Investing: A Practitioner’s Guide to Applying Behavioural Finance"; "Value Investing: Tools and Techniques for Intelligent Investment”; and “The Little Book of Behavioural Investing”. Mr. Montier is a visiting fellow at the University of Durham and a fellow of the Royal Society of Arts. He holds a B.A. in Economics from Portsmouth University and an M.Sc. in Economics from Warwick University."
I have no connection of any kind with GMO LLC, and simply came across their website when searching for a current biography of the author.
James Montier ran a blog called “Behavioural Investing” but I understand stopped posting to the blog when he joined GMO. However his previous blog posts are still there, and are available free.
The articles in the book are divided into eight sections. Below is a brief summary of what the preface says about these sections.
“In many ways one of the most powerful insights offered by the literature on judgement and decision-making is that we are all prone to the potential pitfalls that psychologists have spent years documenting. Indeed, when I give a lecture to professional investors, those who probably get the most out of the talk are those who identify themselves as the perpetrators of behavioural mistakes. The chapters in this section aim to explore some of the most common biases, and suggest some simple ways in which we might be able to mitigate our susceptibility.”
“Among some there is a view that the individual investor is the source of all behavioural mispricing. However, I suspect this is far from true. Indeed there are now a number of papers (such as Jackson, Glushkov) that argue convincingly that the professionals may well be the noise traders. The aim of this section is to demonstrate that professional investors are just as likely to suffer behavioural biases as the rest of us. Indeed, in as much as they are experts in their field, they may well be even more overconfident and overoptimistic than lay people.”
“The aim of this section was to examine a typical large institutional fund management organisation and assess its vulnerabilities to psychological critique. The first step on the road to reform is to be able to identify the areas of weakness in the current structure. Issues such as an overreliance on forecasting, the illusion of trading, wasting time meeting company managements, and the dangers of overtrading are covered here.”
“If the previous section represented a long list of don’ts, then this section is an attempt to provide a list of dos. It is concerned with investment philosophy/process. Since we cannot control the return on an investment (much as we would like to be able to do), then the best we can do is create a process that makes sense. Here we explore contrarian strategies and value investing as a framework for mitigating behavioural biases. As I am also an empirical sceptic, this section contains many empirical chapters based on demonstrating the principles discussed.”
“Of all the areas of behavioural finance none captures the public’s imagination like bubbles. This section explores a paradigm for analysing and assessing bubbles and their paths. It is a good demonstration of the constancy of human behaviour. Every bubble in history has been slightly different, but the underlying characteristics and processes are amazingly similar.”
“We have a bad habit of accepting theories as fact within finance, and of accepting statements as if they were truths. The chapters here try to expose some of the believable but incorrect beliefs that many investors seem to share.”
“We often interpret other['s] actions as evidence of their underlying nature. However, when people find themselves in a situation, we fail to understand the impact that has on their behaviour. So, rather than bad apples it is more often than not bad barrels, and the chapters here explore how psychological insights can improve our understanding of corporate governance. We also explore one of economics’ most cherished beliefs – that incentives work – from a psychological perspective, and the results are intriguing, suggesting that optimal incentives are more difficult to design than many economists would have us believe.”
“This section deals with two of the most popular and most controversial notes I have written. They tackle the heresy of money not equalling happiness, which is clearly anathema to many who work in finance. These chapters explore the issue of what makes us happy, and what we can do to increase our level of happiness. These may seem like unusual topics for a researcher employed by an investment bank, but they were borne out of a belief that some of the most miserable people in the world seem to work in the field of finance.”
In my view this is a book for readers who are already familiar with investments, and not a book for beginners. You already need to be comfortable with the differences between stocks, bonds, convertibles, warrants, options, mutual funds, closed ended funds, etc. It also helps to be familiar with the basics of how markets work, accounting, financial mathematics and company accounts.
For readers familiar with investments, this book is, in my opinion, an absolute gold mine. Each of us is our own worst enemy as an investor. Reading the book will make you aware of so many of your mental failings. Eliminating or reducing even a few of the behavioural biases covered will repay the cost of the book by several orders of magnitude and I recommend it very highly.
It does not matter that the examples are all from around 10 — 15 years ago. Principles never age. Indeed one of the best books I have ever read about investments, "The Theory of Investment Value" by John Burr Williams I read sixty years after it was written!