Book Review: Investing and the Irrational Mind by Robert Koppel

In this book Robert Koppel relates how he has discovered that the precepts and practises that he knew from practical experience lead to market trading success are underpinned, explained and validated by the findings of behavioural finance research.

Not so much a ground-breaker providing new insight or knowledge, it is readable summary and description of many behavioural finance concepts and how they have been applied successfully by traders. But it falls short in explaining exactly how to change one's own behaviour. There is a difference between saying that intuition is a quality of successful traders, which he does, and setting out an action program to get there, which is not done. One wonders if he thinks that may be impossible using only a book since as he also notes, "... none of what success requires is easy. There are no shortcuts, simple answers, or turnkey solutions."

It has been known for a long time what kinds of behaviours and psychological qualities lead to success. Koppel cites an 1880 list - self-reliance, judgment, courage, prudence and pliability. Koppel also relates how certain highly successful traders through extreme determination and unstinting enormous effort managed to change themselves and imbue themselves with the required qualities. That's learning the hard way, self-taught through much trial and error. Is that really the only way? Surely not, in this age of deliberate formal education that turns out vast numbers of people who are better at many things than would have been the case if left to their own devices. There is a little bit of such content in the section on psychological resilience but the book misses the opportunity to take the next step by providing the training-type advice to operationalize improved investor behaviour. For instance, Koppel cites research which concluded that optimism can be learned, an encouraging bit of news. Ok, tell me how to do that. My family and close friends would really like me to know! It is not just a case of "just do it".

Koppel is not particularly to blame in this. So far, no book I have come across goes beyond describing the problems uncovered by behavioural finance to putting in writing a comprehensive practical training program. As a model for what I think can and should be assembled, there is the classic on how to be a good consultant, Flawless Consulting by Peter Block. It is very specific and tells you exactly what to do step by step.

The book reads easily. It contains some amusing quotes e.g. "I have stuff, therefore I am", a fitting epitaph for the consumer society. Another, said to be Wall Street lore, vividly describes the investing risk-return trade-off "You can't eat like a bird and shit like an elephant". It also contains a good reading list and copious references.

Most likely, the greatest appeal of this book will be to the active investor, especially the short-term trader and market timer. Passive index investors will find the admonitions about finding a trading system that gives a person an investing edge somewhat beside the point. One could say that one of the great benefits of passive investing is that it helps bypass much of the harmful stimulation that leads to bad decisions and portfolio loss. Someone who owns a broad market index fund can simply do a Rip Van Winkle - file, forget and ignore for a decade or two, perhaps awakening every few years to rebalance amongst asset classes.

In short, this is a good though not great book. My rating 3.5 out of 5 stars.

Thanks to the publisher McGraw-Hill for providing me with a gratis review copy.

Book Review: What Investors Really Want by Meir Statman

Thought-provoking but at times a dull read. Full of insights but ultimately confusing. That's what my emotion and my logic give me after reading this excellent book.

Thought-Provoking and Full of Insights: When I read finance books I take notes of interesting points and I highlight ideas that can serve me for my own life or for my blogging. This book gave me about twice the usual number of notes and a large number of potential blog post subjects. For example, on page 95 Statman tells us that people typically spend more than the amount of the gift card they have received but less than the cash when they receive cash as a gift ... ergo, suggestion to promote frugality in these frugal times - for Christmas, give cash, not a gift card ... but, people who receive gift cards also tend to buy luxury products they really enjoy that they would not otherwise buy, whereas a cash gift gets spent on mundane items, which means that you might want to give a gift card after all depending on your motives! (oh well, there goes one blog post). The book was also the source for my recent Holiday Financial Tip: Eat Turkey Dinner post. Believe it or not, I also found in the book the simple but true root cause explanation ;-) of the whole credit crunch mess and will be posting soon on that.

There is much serious and substantial topic matter, covering the gamut from the conflict between the hope for riches to the fear of poverty, to the desire to avoid taxes, to the effects of status-seeking. The book is dense with ideas. Indeed, in pure factual terms, it is essentially an extended popularized annotated bibliography of behavioral finance research compiled by an authority in the field (Statman is Professor of Finance at Santa Clara University and has produced many well-regarded papers). As a well-organized - by chapter subject theme (table of contents here on the book's blog site) - comprehensive and documented - 31 pages of fine print footnotes - collection of the state of the art knowledge in this subject area, Statman's book is well worth the price on that basis alone.

Apart from the multitude of small insights that the book recounts and relays from other sources, the book's main insight is that people invest for more than the utilitarian or profit-making value. They also seek a payoff in emotional terms to make themselves feel better, and for expressive benefits to exhibit their own values, tastes and status to themselves and to society. Instead of portraying behavioural finance as a negative series of biases and errors contrary to rational behaviour, Statman says that much, though not all of it, actually is a positive feature of investing. There isn't always only one answer or one best outcome - maximum profit - for all investors. However, I suspect that his suggestion that it is good to invest for fun and status - "we should enjoy all the benefits of investments - utilitarian, expressive, and emotional" (p.241) - would quickly take a back seat to utilitarian money if losses began to accumulate.

Dull: I believe it's mostly due to the nature of the book as a collection of very disparate ideas, since the writing style is simple, direct, informal and understandable, but I needed to force myself along through the pages. The book is not a gripping tale with flow that pulls the reader through. However, the frequent nuggets of gold make the effort worthwhile. It reminded me of my experience in a former business life of attending business conferences - most talks are a waste of time but one or two good ideas or contacts - make the cost and effort of attending worth it. This book has more than one or two good ideas.

Confusing: The deluge of motives and forces that Statman describes chapter after chapter eventually becomes overwhelming. Two or more interpretations may be possible for any action or situation. What makes it worse is Statman's admission in the final chapter: "It is often hard to distinguish facts from from cognitive errors and even harder to distinguish cognitive errors from wants or expressive and emotional benefits." (p.237) On the next page, I believe Statman is right when he says "I see no benefit in cognitive errors that mislead us into sacrificing utilitarian benefits for no benefits at all." How do we differentiate the errors from the expressive and emotional benefits and what should we do?

The answer to this last question is not be found in the book. His effort is a descriptive tome. To be fair, Statman evidently did not aim to answer the question so he cannot really be faulted for the missing piece.

Maybe we are meant to read it all, digest it and fabricate our own answers. I believe, however, that what many, if not most, investors really want and need is a prescriptive book that incorporates all the lessons and observations to tell people what to do. Hopefully, someone will write it soon. Statman would have the perfect follow-on title - What Investors Really Need, subtitled Apply (instead of the present book's "Want" and "Learn") the Lessons of Behavioral Finance.

Nevertheless, this is a fine and useful book for the individual investor to spur self-analysis and self-knowledge of his/her own personal finance and investment emotional and expressive drivers.

My rating: 4 out of 5 stars.

The Marshmallow Test, Commitment and Life Success

One of the keys to financial success is controlling desires for immediate gratification by saving instead of spending every penny that comes into our grasp. Such tendencies become visible early in life, it seems.

Long ago a researcher named Walter Mischel tested how well 4 year olds could resist the temptation of one marshmallow now instead of the reward of getting two scant minutes later. The hilarious Kids and the Marshmallow YouTube video re-enactment of the experiment shows how tough it is for kids to resist the urge to gobble up the marshmallow right away.

Some kids are naturally better at it than others. Mischel's and other studies reviewed (see pp 19-21) in the paper Commitment Contracts by Gharad Bryan, Dean Karlan and Scott Nelson of Yale University found that children who are better at deferring gratification are more successful later in life, being more able to concentrate, live with frustration, get higher SAT scores, use drugs less and be perceived to be more competent by parents and peers.

Having a tendency does not necessarily mean an inevitable fate. Humans are wonderfully adaptable and control measures can be put in place to counter such harmful tendencies. This quote from Commitment Contracts is encouraging: "Children were able to wait longer when their attention was shifted, when they could not see the reward, when they were in a cold state (when children were told to think about the abstract qualities of the marshmallow), rather than a hot state (when children were told to think of the taste) and when they were told to be task oriented rather than reward oriented. (Thinking about their aim, rather than what the rewards would be like)"

One direction for correcting and controlling the "I want it now" behaviour that harms not just children but adults too (think of the gap in savings for retirement) is, according to these authors, to put in place Commitments. Commitments can be either hard, with actual costs, or soft, with psychological costs. A hard example: you promise to lose 10kg by July 1st, and you pay someone if you don't achieve that. Soft commitment example: not having junk food in the house.

Dean Karlan believes enough in the principle of making a commitment as an effective way to modify behaviour to have co-founded a special website called StickK where anyone can make a formal Commitment. It seems to be for real. When you sign up, you are contracting to pay and they promise to enforce payment if you do not meet whatever goal it is you yourself define. One of the other co-founders, Ian Ayres, recounts in his book SuperCrunchers how his own successful hard commitment experiment to lose and keep off weight made him a believer too.