The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy
By James Montier
Wiley, New Jersey, 2010
The study of behavioral finance is the new frontier in understanding the investment process and in constructing viable portfolios that may survive and thrive even in times of massive dislocations.
Analysis of factors that influence the way we behave as investors has been around for years (in addition to Montier, you can read the works of Robert Shiller, Dan Ariely, and Andrew Lo), but until recently it was always overshadowed by the mainstream approach, based on market efficiency and rational expectations.
The latest financial crisis and the indiscriminate blow-ups of financial models have finally showed the massive limitations of the Efficient Market Hypothesis (EMH) and ensured work for years to come for behavioral economists.
James Montier, often called “the enfant terrible” of finance for his irreverent approach and critique of the financial orthodoxy, established himself as an authority on the subject with different works such as Behavioral Finance, Behavioral Investing, and Value Investing. For the causal reader and curious investor, he also put together this short and concise pamphlet on behavioral investing as part of the Little Book series.
It is an insightful look into the real, yet most often disregarded dynamics that affect our behavior when we are thrown into the investment arena. He talks about the foolishness of forecasting (see Nassem Taleb’s work for more on this subject) and the notorious practice by Wall Street analysts of publishing stock target prices (indeed one of the most idiotic wastes of times in the industry).
Montier also touches on the subject of bubbles in asset prices—how to define and spot them and why they arise. Along this subject, he writes about a series of behavioral tendencies that mark the human process when it comes to investing:
- Over-optimism, which blinds us from the dangers posed by predictable surprises.
- Illusion of control, or the belief that we can influence the outcome of uncontrollable events.
- Self-serving biases or the innate tendency to overweigh information that validates our biases.
- Blindness of inattention, or the fact that we do not expect to see what we are not looking for.
In conclusion, Montier provides an interesting and fact-supported look at how our emotions prevent many of us from being successful investors.