Beat the Crowd: How You Can Out-Invest the Herd by Thinking Differently

CHAPTER 9 When Miley Cyrus Meets Ben Graham: Misadventures in Behavioral Finance

We’ve spent the past eight chapters honing our brains. Can you feel your head oozing outlying thoughts yet?

If so, don’t get too excited. All the smarts in the world are often no match for our biggest enemy—ourselves. The emotions and biases that drive us to make the wrong moves at the wrong times.

There is an entire field devoted to this. Behavioral finance, one of my favorite areas of market research. Behavioral finance, correctly applied, is all about finding ways our brains and feelings trick us into making the wrong moves most of the time. Its goal is to help us all control the emotional impulses and biases that bring bad investment decisions. Behavioral finance is our weapon against our inner Jesse Livermore.

At least, that’s what behavioral finance is supposed to be about. In recent years, the field has shifted from “how to control yourself” to “how to beat the market.” “Behavioral finance funds” claim to gain an edge by identifying and exploiting mass behavioral errors, and they charge a premium for their supposed specialization. More power to them for trying to game the crowd, but this isn’t behavioral finance! Behavioral finance is supposed to be about identifying your own cognitive errors and fighting the urge to repeat them, not exploiting others’ mental goofs. Assuming others are stupid is usually arrogant, sometimes simply stupid, and usually not the best basis for a bet.

Newfangled ...