Jason Zweig writes The Intelligent Investor column for the Wall Street Journal and is interviewed here by Shane Parish.
Lots of useful stuff, starting for me from about min 26 of the podcast onwards, here are my highlights as well as some of my own complimentary thoughts:
1. One of the biggest distorting forces in financial markets comes through misalignment of incentives (eg. Brokers paid commission encourages turnover). I think this is one of the greatest truths of financial markets. Charlie Munger also points it out as one of his key mental models, never ever underestimate the power of incentives:
I think I’ve been in the top 5% of my age cohort all my life in understanding the power of incentives, and all my life I’ve underestimated it. And never a year passes but I get some surprise that pushes my limit a little farther.
The way you pay your financial advisor, or your investment manager, your staff, your business managers very very strongly dictates whether or not their interests are aligned with yours. He also talks a lot about how to create greater trust between advisors and their clients through better alignment of incentives
An insight from early in my career when I worked on the financial incentive structure for a team of financial service salesmen: these incentive structures are massively powerful but also cannot remain static. Most incentive structures are not perfect. Usually when you implement a new structure to begin with it has the desired effect but after a year or two the participants understand it and start gravitating towards exploiting its weaknesses at which point in time it’s usually a good time to modify it further.
2. It’s very hard in financial markets to tell the difference between good and bad advice. Outcomes are disperse with many driving factors, narratives are only clear in retrospect and easily misappropriated (see earlier post on Narrative Fallacy). Sometimes outcomes can take years to play out and we judge them over shorter time frames. How could you go about judging this: focus more on their process, ask for evidence that that woks in the long term rather than the short term outcomes and watch those incentives very carefully.
3. We tell ourselves lies every day just to live life effectively, to get ourselves out of bed and moving forward. We think we are better than average at almost anything we do otherwise why get out of bed and do anything? We believe in a “Just world” (a psychological paradigm/theory propagated by Melvin Lerner): The underlying belief we have is that most of us are “good” and good things happen to good people, bad things happen to bad people and that we will get what we deserve. If you are a good investor (you do the right things diversifying your portfolio, controlling costs etc) you will get a good outcome. We are devastated when that illusion is stripped away, when bad things happen to good people and we conclude that they must have been a bad person in some way:eg. a bad outcome for a good investor, or a crime committed against a person; we can often be influenced by this set of beliefs to rationalise that the victim/good person must have done something to deserve the outcome. The financial crisis of 2008 stripped away this illusion vey completely where investors followed “good” advisors and lost a lot of money and Jason believes this has broken down a great deal of trust between financial advisors and their clients. (see minute 42 onwards)
Investment decision making
4. Your decision making needs to be evidence based, not intuition based wherever possible. However you also need creativity to see the connections that others do not. These two are in a bit of tension.
5. He gives an absolutely brilliant definition of risk:
Risk is the difference between what investors think they know and what they end up learning about their investments, about financial markets, and about themselves.
But he glosses over discussing this. The reason I think it is so brilliant is it encapsulates three different types of risk we face when we make investment decisions
A. The investment itself turns out to be different from what we expected eg. Earnings disappoint, cashflow disappoints and it goes bankrupt
B. It may be that the investment performs exactly as they expect fundamentally, but financial markets end up pricing it way different from what they expected. Eg. Nominal economic growth is 4 % but bond yields are only 2.5 %, to highlight the thing investors have been most surprised by in the last decade: how low bond yields can go and stay
C. And most importantly, about ourselves. About our emotional reactions to losses, our ability to remain rational during periods of pain. Most of us suffer from tremendous loss aversion, as behavioural economists would call it.
6. The power of not trading. “Both buying and selling are a form of hubris” believing that you know more than other people, or that you have some unique insight into a situation. I am pretty sure this does not apply to every investor as I have seen some very effective investors operate with a very active style but there is definitely a difference between knowing when to act and when you are just reacting to the noise.
7. Minimising risk by simply not being overconfident in your views, a very powerful way of ensuring you don’t blow up, don’t put everything on one bet,
8. To flourish in a bear market you need two things: cash and courage. So going into a bear market you need to make sure you have the cash otherwise there is no chance to have courage. This is not easy, very few institutional investors ever raise cash, they tend to remain fully invested. And there are many situations in bear markets where institutional investors are not given the option to invest because either their clients are panicking or because they have not managed their liquidity and risk appropriately. And in the midst of a bear market it’s very difficult to have courage. Great quote from Benjamin Graham on the subject from the depths of the 1932 crash:
Those with the enterprise lack the money, and those with the money lack the enterprise to by buy stocks cheap
9. Needing to know your own temperament and understand your own emotions is absolutely essential as an investor.
To be a good investor you need independence, scepticism, good judgment and courage. Easier said than done.
In his opinion the best investors are “inversely emotional”. They need to be a little on the autistic spectrum: able to see that others are experiencing severe emotions but able to detach themselves from that emotional gravitational pull and go in the opposite direction. Again interesting examples of Benjamin Graham being described as “Humane but not Human”, Charlie Munger as being simply “rational”.
10. So if you are a regular human being, not on the autistic spectrum, can you teach yourself to be “inversely emotional” like this?
It’s not easy. You have to put policies and procedures in place to help manage the emotions. If you are an alcoholic you don’t walk past the bar on the way home. So avoid stimuli and shut off noise that could distract. Focus on and listen to analysis that’s rational and unemotional. How do you put the right governors in place to manage the emotions during a decision making process? To avoid the temptation to react to short term performance and pain of loss but not to be complacent either? To avoid the enthusiasm of a new idea and seeks the world might be different going forwards from the past even when past patterns are different.
Danny Kahneman says its very difficult to do as an individual but it may be possible to do as an organisation with the right structures in place.
If it is possible to do as an organisation, I suspect it is still very very difficult to do, and most will fail. That is because it takes much more than structure, though structure is a prerequisite. It takes an incredible culture. That’s because the the pressures to conform with a crowd are already operating at a small number of people, it’s hard to be independent and diverse even among a group of colleagues. To not be swayed by the myriad of cognitive biases we each have interacting with each other is a big challenge. Not to allow group think to quickly dominate an idea.
We will have to work very hard at establishing the culture as one that is both creative, but also evidence based and rational rather than driven by emotions which are the natural drivers of many of our actions at a level we ourselves may not even be aware. We need to have good mental hygiene! How to do this practically is, I think this is the topic of a whole separate blogpost!
11. Once again value of history, really understanding the lessons of history. Be a student of financial history!
Here is the link to the podcast:
Listen to Elevate Your Financial IQ from The Knowledge Project with Shane Parrish in Podcasts. https://itunes.apple.com/gb/podcast/the-knowledge-project-with-shane-parrish/id990149481?mt=2&i=1000354857225