Posts filed under “Cognitive Foibles”

A Secret Wall Street Brainwashing Machine is Wholly Unnecessary

Every now and again, I disagree with an article written by someone I like and respect. On occasion, an author will crank out a column that makes me angry. And on rare occasions, I will read something where I disagree with just about every sentence.

Today is one of those total disagreement days.

Marketwatch columnist Paul Farrell wrote an article on behavioral economics with the headline “Why investors are helpless against Wall Street’s secret brainwashing machine.” I can find fault with just about every thought in the piece, including his mention of “robots” in Ridley Scott’s film “Blade Runner.”

No, behavioral economics isn’t being used to manipulate 95 million Americans.

No, Wall Street doesn’t have a secret mind-control brainwashing machine.

No, the study of behavior hasn’t determined that humans are born rational, and can therefore become “less irrational.”

I have been studying behavioral economicscognitive errors andneuro-finance for almost as long as I have been working in finance. And while I don’t pretend to speak for the field, I can say I have learned a bit about it. Not only have I concluded that studying human behavior can make you a better investor, I will show you proof below that this is happening.

First, let’s start with the basic premise. Behavioral economics is grounded in the idea that homo economicus (economic man) fails to account for real-world human behavior. The behaviorists argue that people are not rational; they don’t act narrowly in their own self-interest as profit maximizers. Instead, they are biased and emotional and often fail to make rational judgments about money.

In other words, the traditional starting point of economics is actually false. As a model, it helps conceptualize commerce, but in the real world it can be and often is wrong. This is where the behaviorists come in to show how peoples’ irrationality affects their decision-making. Specifically:

– We get too emotional about the possibility of making lots of money;

– We get too depressed about the risk of losing money;

– Our cognitive processes fool us constantly into believing things that are untrue;

– We have poor impulse control, an inability to think long term and lack patience.

Nowhere does behavioral economics promise to make you as a human being less irrational. At best, its goal is to inform you of your own irrational tendencies. If that information helps you make better, more rational decisions about money, then that’s great — but the claim that this line of understanding is going to trump several million years of human evolution is just silly.

Next, let’s acknowledge that investors act irrationally all the time. The list of cognitive errors and emotional foibles is too long to list here. It’s no secret that salespeople and marketers in finance have become very good at pushing peoples’ hot buttons. How do you think they gin up so much excitement about the latest initial public offering or any of the other sexy products that flood the industry. There’s always a new top money manager, a hot stock with a story, smart beta that beats the market, market-timers, whatever flavor of the month is catching the public eye — all of it and more plays to our worst impulses.

But before you become too cynical, consider the other side:

• Vanguard’s assets under management have at least tripled to more than $3 trillion since the end of the financial crisis. About two-thirds of those assets are in broad, inexpensive passive indices;

• Exchange-traded funds let investors gain broad exposure to almost any asset class in a single purchase at very low cost;

• Asset allocation can now be had for little cost or free via all manner of automated software-based advisers.

Rather than brainwashing investors, behavioral economics has helped create a set of investing alternatives that meet their financial benchmarks and cost very little.  That you may have chosen to ignore these alternatives and plunge into the latest fund of funds or private-equity offering isn’t a failure of behavioral economics; it is your own failure to apply what we now know about investing.

All the social sciences do is provide a framework for thinking about how people interact, how groups develop and how all of these interact with each other. The basic premise of economics is that transactional commerce — the production, distribution and consumption of goods and services — is a key way to understand society. What behavioral economics has done is point out the false assumptions and erroneous conclusions inherent in the dismal science of economics.

I will agree with one thing Farrell wrote, though: Wall Street doesn’t want rational, informed investors. But then again, Detroit doesn’t want informed and rational car buyers; supermarkets prefer hungry shoppers guided by their stomachs and not their heads; retailers love impulse buyers. Indeed, consider any transaction you might make, and the person on the other side of the trade much prefers to have all of the information while you react emotionally.

Your wetware developed to keep you alive on the savannah, not to make risk-reward decisions in the capital markets. A secret brainwashing machine is unnecessary. You are not wired for investingYou never were. That is a feature, not a bug. But our brains have allowed our species to survive long enough to develop expensive, unnecessary financial products.

It is your job to figure that out. Behavioral economics can help.


  1. They are replicants, not robots in “Blade Runner” — genetically engineered creatures composed entirely of organic substance.  

Originally published as: Wall Street Doesn’t Need to Brainwash You 

Category: Asset Allocation, Cognitive Foibles, ETFs, Investing, Psychology, Really, really bad calls

Create Your Own Stock Market Narrative!

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Category: Cognitive Foibles, Financial Press, Markets, Psychology, Really, really bad calls

Average Returns Are Exceedingly Rare

One of the most fascinating things about markets is the sheer volume of data they generate. Every day, millions of data points get created. The vast majority of this amounts to little more than noise. This endless stream of information leads thousands of us everyday on a hunt for meaningful signal amid the cacophony. Most of the time, we…Read More

Category: Cognitive Foibles, Investing, Markets

Don’t Let Bias Corrupt Your Analysis

Those of you who over the many years have followed some of the thoughts and observations I jot down each morning may have noticed several themes. Prominent among them is that forecasting is folly; cognitive errors create investing mistakes; consider context when analyzing data; recency bias overemphasizes the latest data; mixing politics with investing is…Read More

Category: Analysts, Cognitive Foibles, Politics, Psychology, Really, really bad calls

Daniel Kahneman: The riddle of experience vs. memory

Using examples from vacations to colonoscopies, Nobel laureate and founder of behavioral economics Daniel Kahneman reveals how our “experiencing selves” and our “remembering selves” perceive happiness differently. This new insight has profound implications for economics, public policy — and our own self-awareness

Category: Cognitive Foibles, Psychology, Video

Explaining the Explainers

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Category: Cognitive Foibles, UnGuru

What March Madness Can Teach US About Investing & Trading

We are down to the Sweet 16 in the NCAA’s men’s college basketball tournament, otherwise known as March Madness, which depending upon your perspective is either the most exciting month in sports or the American collegiate plantation system writ large. As is my wont, I seek out lessons in what I see, hunting for parallels in sports, politics, et…Read More

Category: Apprenticed Investor, Cognitive Foibles, Investing

Gold Narrative Has Just Not Worked

Category: Cognitive Foibles, Gold & Precious Metals, Media, Really, really bad calls

Gold Turns Negative Year-to-Date; Stocks to Follow

Equity markets started off this year by falling. They rallied in February, working their way back into the green. The Standard & Poor’s 500 Index now is up about 1 percent for the year. Gold has traveled the opposite path: The yellow metal began at about $1,175 an ounce. By Jan. 23, it had rallied…Read More

Category: Cognitive Foibles, Gold & Precious Metals, Really, really bad calls, Trading

Anniversary of Crisis Lows Is a Psychology Reminder

Exactly six years ago today, the markets made their ultimate low following a 57% collapse of the S&P. I was fortunate to have been on the right side of that trade in both directions. What is most fascinating to me about that was the pushback from traders and investors — in each direction. It is revealing…Read More

Category: Cognitive Foibles, Investing, Markets, Psychology