NY Magazine recently interviewed James Grant, well-known financial philosopher, to get his take on the economy and financial markets. The article is full of nuggets of wisdom, including the following:
Grant’s second cause for optimism is an observation about human nature, summed up by an epigram he borrowed from the late British economist Arthur C. Pigou: “The error of optimism dies in the crisis, but in dying it gives birth to an error of pessimism. This new error is born not an infant, but a giant.” As peculiar as our economic circumstances may seem to us right now, the way people behave has a certain reassuring constancy—which is to say, we freak out and then we get over it.
Human behavior, if left unchecked, makes it virtually impossible to generate superior investment results over time. The wide swings in optimism and pessimism that are part of the human condition present a serious challenge to the flexibility required to capitalize on investment opportunities. Rather than trying to train ourselves to be emotionless (which won’t happen), our solution is to rely on systematic relative strength models (which are emotionless.)
The reality is that there are times when we should be pessimistic and times when we should be optimistic, but without a system to overcome behavioral tendencies, we are likely to be unable to capitalize on those opportunities.
In this and other blog commentary, you’ve made some very pungent, striking, and entertaining comments about human behavior. Do you have some examples that could be used on an audience (any size) during a presentation of RS investing that could serve as an illustration. and bring this home? We can all nod our heads and agree and point our finger at the other guy when you cite your examples, but this applies to us as well! As an example and you are probably aware of this, and I don’t know if it qualifies, but if you ask a group to raise their hands or write down which category of driving skill they possess, above average, average, or below average, a majority of people will choose above average or high average which of course everyone can recognize as silly and untrue. Any thoughts or examples? Thanks, Roy
Roy,
One good resource for illustrations of behavioral finance might be Dan Ariely’s book “Predictably Irrational.” I have heard him speak and he did a great job of serving up all kinds of illustrations about just how susceptible we all are to behavioral pitfalls. Thanks for your comment.
Andy