Posts filed under “Psychology”

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

Post Traumatic Crash Disorder & the 1962 Flash Crash

click for ginormous chart Source: Bloomberg On this day 53 years ago, Wall Street had one of its worst sessions ever. As the Wall Street Journal reported, “The Dow Jones Industrial Average fell 5.7%, down 34.95, the second-largest point decline then on record.” It was part of a longer decline that some called the “Kennedy Slide…Read More

Category: Markets, Psychology, Sentiment

Do Strong Religious Beliefs Stifle Innovation?

Source: Real Time Economics

Category: Data Analysis, Digital Media, Philosophy, Psychology

Create Your Own Stock Market Narrative!

What makes this so good is how dead on accurate this collection of cliches have become:     Click to create your own personal narrative. You may even get your own punditry spot. Source: Stockcats     How awesome is this?!

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

2015 Pace of Social Change

Click for other social issues. Source: Bloomberg

Category: Digital Media, Politics, Psychology

The Remarkable Life & Lessons of Ronald Read

    My Sunday Washington Post Business Section column is out. This morning, we look at the remarkable life and lessons of Ronald Read. It is a fascinating tale. Here’s an excerpt from the column: “You may have read about the remarkable life and times of Ronald Read. He was the gas station attendant and…Read More

Category: Apprenticed Investor, Investing, Psychology

Nasdaq Bubble Stole From Future Returns

Yesterday, we discussed why the Standard & Poor’s 500 Index has gone sideways for the past few months. The prime suspects were rich valuations, earnings crimped by falling energy prices and higher returns to be had overseas. Today, I want to look at the Nasdaq Composite Index. It closed at 5,056.06 yesterday, surpassing its March 2000 dot-com…Read More

Category: Markets, Psychology, Sentiment, Valuation, Web/Tech

The Market Rhythm Deciphered

Source: @Trader_Dante

Category: Cycles, Humor, Psychology, Trading

Source: Aeon

From Aeon:

Since 1986, the amount of information we absorb has increased fivefold and our options for getting more have become almost limitless. All this choice and access to data might seem like a luxury of contemporary life – and in some ways it is – but recent neuroscience studies have shown it’s making our brains work overtime. As it turns out, we aren’t just bad at multitasking, we’re not equipped for it at all. In fact, we’re just switching between tasks, which uses up neural resources that would otherwise go towards actual problem-solving.

In this talk at the Royal Society of Arts in London, Daniel Levitin, a professor of psychology and behavioural neuroscience at McGill University in Canada, reveals the surprising effects that ‘information overload’ is having on our brains, and how we can best combat the data deluge. Some of the proven strategies, like taking short naps to recharge, could go beyond simply preventing brain drain and helping us maintain focus, but might actually make us better, more creative problem-solvers too. In fact, Levitin makes the case for regular daydreaming – 15 minutes every two hours – so that our brains benefit from a restorative mind-wandering mode, which he describes as their natural state.

Category: Psychology, Video

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