Henri «tte M. Prast  Henri «tte Prast is a Senior Economist at the Nederlandsche Bank (Dutch Central Bank) and Associate Professor in Money, Credit and Banking at the University of Amsterdam. She has published on various subjects, including central banking, inflation and unemployment, regulation, and the role of psychology in financial markets. Currently she is specialising in Emotionomics, a term she has coined to describe research into the role of emotions in economics. She writes a weekly column on Emotionomics in Dutch financial newspaper Het Financieele Dagblad . The emotional investor -
Take control of your own investments. Keep in mind that fund managers and investment analysts aim to maximise not your return, but their own future income, which depends on their reputation for being smart. Keynes observed that: "It is better for reputation to fail conventionally than to succeed unconventionally." By disappearing in the crowd , professionals make sure that their mistakes will be forgiven, as others made the same faults. This mediocrity preserves their reputation, but does not enhance your return. -
Don't be conventional. A corollary of the first rule - since you should be more concerned with returns than reputation - is to avoid convention. Keynes' observation may have been right for financial industry participants , but only for those with mediocre talents - and not for readers of this book! -
Blame your faults on yourself, not others. 'Heads I win, tails it's chance.' Blaming someone else for your mistakes, and claiming the honour for your successes, may seem pleasant, but it does not make you either good company or a good investor. Moreover, you won't learn from past investment mistakes. Cognitive psychologists have labelled this behaviour ' biased self-attribution'. It leads to another empirically verified phenomenon : individuals are, on average, overconfident. If you are overconfident, you trade too much, as you think you are smart enough to see valuable information in what is actually irrelevant news. The excessive trading lowers your return, as transaction costs exceed the return from trading. -
Dare to be a loser. Do not expect all your investments to be successful. Even the best investors are not right all the time. In a success-oriented culture this is a difficult lesson for many investors to learn. But the success of each individual trade is not as important as the profitability of the whole portfolio. Sometimes it is necessary to sell the losers, for the sake of the wider portfolio. In military terms, some battles have to be lost to win the war. -
Watch out for starry nights. Experimental studies find strong evidence that investors chase trends once they think they see them. This is because, as psychological research shows, we have a tendency to see patterns in random events. For example, in a random pattern of stars we are determined to see the Great Bear. Due to this phenomenon, which is called the 'representativeness heuristic', we overestimate the news value of one element in a series of similar messages. As a result we over- react to information that is part of a string of similar, but unconnected, events. -
Hip is out: stay away from cascades when you see one. As our private information is never perfect, we infer much from the behaviour of others. The cascade model of investment predicts that we tend to follow others, perhaps neglecting our own valuable information. Try to think of investments as places to eat. When you see a queue outside a restaurant, you might conclude that it is a great place to eat. However, that queue might be there precisely because the person last in line followed your reasoning, and the one before him did too etc. Rely on your own information unless you are sure that others know more. The cascade may change direction quickly and in that case it is unlikely that you will survive. -
Beware the gambler's addiction . Addicted gamblers want to lose, not win. That is why they are easy prey when it comes to beating 'the market'. According to Freudian psychoanalysis, the addicted gambler is motivated by his repressed Oedipal conflicts. The male child's wish to become his mother's object of desire creates an ambiguous relationship (love/hate) with the father. Destiny is an avenging father substitute, and gambling challenges it. By losing, the gambler pays off his moral debt to his father. Important: before entering a casino you should see a psychiatrist to make sure you do not suffer from this neurosis! -
Crisis, what crisis? We tend to be 'disaster myopic'. If a long time has elapsed since the latest crash, we believe it will never happen again. Stay awake and look out for signs indicating that a crisis is looming around the corner. -
Don't fall in love with your portfolio - or it will betray you. According to cognitive psychologist Leon Festinger, we filter information to make it correspond to our fundamental opinion. Think of wishful thinking by a person who is in love and does not see the nasty habits of the objects of his desire. Investors, similarly, tend to turn a blind eye to information that does not suit them, and actively search for information that confirms that they have made the right investment decision. Be aware of this, and don't turn away from bad news about your portfolio. -
Carpe diem. Sit back and reflect before even thinking about investing. Remember that the purpose of investing is future consumption. Reconsider whether you really want three pairs of Jimmy Choo shoes by the time you are 65 rather than one pair of them now. www.dnb.nl 'If the Price-Research Ratio (share price divided by R&D per share) is 5 or less it is nearly always worth buying the shares. This applies particularly to recovery situations.' ”Conor McCarthy | |
