I recently spent some time at my local Barnes and Noble looking at the shelves of investment books. I found many of the titles to be comical (even funnier than "The Naked Portfolio Manager," if you can believe that!). There was a consistent theme with each book that I thought was dangerous though. Let's look at some of the titles:

1. "Fire Your Stock Analyst: Analyze Stocks of Your Own"

2. "The 100 Best Stocks You Can Buy"

3. "(You) Invest Like a Shark"

4. "(You) Day Trade Online"

5. "(You) Get Rich with Options"

[With the last three titles, I have added the word "you" in parenthesis.] Two things are implied when you purchase these titles. Number one: The information each book offers is useful to you for the purposes of making investment decisions. Number two: You, the investor, can apply this information effectively to improve your investment results. With this analysis, I will ignore the first assumption and concentrate on the second.

On page 54 of "The Naked Portfolio Manager," I write about a study conducted by a scientist named Hillel Einhorn about three pathologists. The pathologists were asked to look at a series of slides and evaluate nine specific risk factors affecting Hodkinson's disease patients. All of the slides were of deceased patients. The question that Einhorn was studying was whether the pathologists could use their analysis of the nine risk factors to determine the patients' life expectancy with any degree of accuracy.

Einhorn found that the pathologists were able to accurately assess the nine risk factors, but were not able to use those risk factors to make accurate predictions about life expectancy. Using their risk assesments, Einhorn developed a model that was reasonably accurate in predicting how long the patients survived after the biopsies were taken.

How does this apply to the aforementioned investment tomes? Even if the information in the books is useful, there's no guarantee that the average investor, who is subject to emotional decision-making (picking stocks based on emotion), will be able to use the information effectively. The great thing about "naked strategies," which eliminates human error, is that you don't need specialized knowledge or expertise to apply them. Brilliant men have created the model for you. I have listed several of these models in the book and given references as to where you can find more models. All you need to do is follow them. That's one of the things that sets the information in "The Naked Portfolio Manager" a part from other books.

Labels: decision-making, emotions

Last week, I had the opportunity to visit Sweet Briar College and review the progress the students are making in developing their "naked strategies," or rules-based methods for portfolio management.

Many of the ladies had the makings of really great models. I was especially intrigued by a model developed by Heather McPheeters and Andrea Jones designed to capitalize on opportunities in the currency markets. Lindsey Davis and Morganne Young also both seemed to have an excellent grasp of how to apply statistical prediction to making investment decisions.


[By the way, if your reading this at Sweet Briar and you don't have a copy of The Naked Portfolio Manager yet, I think the bookstore still has a few copies!]

Labels: emotions, human error, rules, Sweet Briar

Continuing with the "Emotional Brain" from my previous post, Cordelia Fine explains that researchers cannot tell the physiological difference between when a person is either excited, afraid or angry.

She gives us this formula: Emotion = Arousal + Emotional Thought.

So when a person hits a 100 to 1 shot at the race track, or discovers his brand new car has been vandalized, or runs into an old flame who tells him she is available, that person has the same physiological reaction. The racing heart and the increased breathing are no different. What is different are the person's emotional thoughts.

This can cause some rather strange results. Cordelia points out a study in which a group of young men were told to do some strenuous exercise and then watch an erotic film. Some of the men watched the film immediately after exercising; others after a brief rest and still others after an extended break. The men who watched the film after only a brief rest reported the film was much more stimulating than the other two groups.

Researchers theorized that the men who had watched immediately after exercising attributed their racing hearts and accelerated breathing to the exercise. Those who had an extended rest had time for their heart rates and breathing to return to normal prior to watching the film. But those with just a brief rest actually confused the physical arousal from the exercise with their thoughts about the film.

As I read this chapter from Cordelia's book A Mind of its Own, I couldn't help but think of Abraham Lincoln and the letter he wrote to General Meade after the battle of Gettysburg. The defeated Confederate Army had retreated, but when they reached the Potomac River, they had to stop and wait for the river, swollen from the rains, to subside before they could cross. Demoralized and their supplies depleted, the Army of Northern Virginia could have been routed had Meade pressed them. But instead he hesitated and Lee escaped. Lincoln was furious with Meade for what he thought was an opportunity to crush Lee’s Army and end the war immediately. He wrote Meade a letter dated July 14, 1863 in which he severely chastised Meade for his inaction. But President Lincoln never sent the letter. It was found in his office after his death. Lincoln ultimately found the General who could get the job done.

Decision-Making Best Practice #3 (similar to #2): Learn from Lincoln. Avoid making important decisions when you are upset or angry. High emotions can only confuse or cloud your decision-making.

Labels: cordelia fine, emotions

Injecting emotion into the decision-making process hardly ever leads to the best result. But surprisingly, Cordelia Fine suggests emotions play a huge role in human decision-making in subtle ways that few people understand.

Labels: cordelia fine, emotions