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What do you know that others don't?
By Bob Tattersall
TORONTO (GlobeinvestorGOLD) - The Boston Security Analysts Society recently hosted a two-day conference on the topic of “The Efficient Market and Behavioral Finance.” In spite of the esoteric title, there were over two hundred investment professionals in attendance, so this is clearly becoming a mainstream issue for investors to address.
In simple terms, the devotees of behavioral finance argue that the stock market cannot possibly be efficient because there are a number of strategies which consistently deliver above average returns. Examples of these strategies would include portfolios of small cap stocks or value stocks. Since these past excess returns are well-documented historically and are widely-reported in the press, the behavioral finance theory is that when we are faced with these same opportunities in real time, we simply cannot bring ourselves to act on the basis of historical precedent. In other words, we have behavioral and psychological barriers which overwhelm our rational thought processes.
As an investor in “deep value” stocks, I have some sympathy for this explanation. Many of our potential clients follow the intellectual process of identifying value stocks with great interest, but then express distaste for the collection of “dogs” which are candidates for purchase in their portfolio today. The speakers at the conference offered all manner of explanations for this disconnect between our rational mind and our emotional response, but if you missed the conference or couldn’t afford the registration fee, then there is a $34.00 alternative which covers much of the same ground.
“The only three questions that count. Investing by knowing what others don’t” is a recent book (Wiley: 2007) by Ken Fisher, who runs a money-management firm and is a long-time contributor to Forbes magazine. The book covers the same behavioral issues that were addressed at the conference, but from the viewpoint of an individual investor.
Mr. Fisher begins by admitting that there is really only one question an investor needs to answer: “What do you know that others don’t?’ Unless you have regular access to inside information, this is not a helpful starting point, so he then breaks the question down into three sub-parts for it to yield useful investment decisions. His three questions are: 1) What do I believe that is actually false? 2) What can I fathom that others find unfathomable? And, 3) What the heck is my brain doing to mislead and misguide me now?
As you can imagine, the book tackles each of these questions in great detail (it is, after all, 450 pages long), but the primary theme is to encourage out of the box thinking. Questions 1 and 2 are intended to avoid basic errors and encourage non-traditional research, and question 3 clearly enters the realm of behavioral finance. Which brings us back to the first question: “What do you know that others don’t?” We now realize that both Fisher and the behavioral finance professors are saying the same thing: To be a successful investor you must first know yourself, and that is something that others don’t.