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The Muscular Portfolios Newsletter — No. 24 — Mar. 2, 2020
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Do you make these behavioral errors?
 By Brian Livingston
One of the most important scientific findings of this century for investors is the fact that our unconscious behaviors can seriously lower our gains. The book Muscular Portfolios explains this in Figure 1-15 of Chapter 1 and in more detail in all of Chapter 14.
Now an entire volume has been written about the ways we humans suffer from our completely unconscious behaviors. Most importantly, the new work gives us a chance to do something about the problem.
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 Psychological Barriers to Successful Investing by John Shelton Ph.D. is the latest in a series of books that reveal exactly how these “hidden performance stealers” operate below our conscious awareness.
Fortunately for investors, the field of behavioral finance is finally receiving some of the recognition it deserves. The Nobel Prize in Economics was awarded in 2002 to Daniel Kahneman and Vernon Smith for providing evidence of how unconscious behaviors hurt our investment results. Kahneman’s subsequent 2011 book, Thinking, Fast and Slow, reveals how our emotions rule our financial decisions, without us ever becoming aware of it.
Adding to these honors, the Nobel was awarded in 2017 to Richard Thaler for his pioneering experiments. His 2008 book, Nudge (with Cass Sunstein), had already become influential for showing how mere suggestions by an employer or a public agency can improve employees’ long-term gains.
Shelton’s book joins the works of Nobel laureates such as Kahneman and Thaler in holding a mirror up to our thoughts and showing us how our unconscious impulses can seriously hurt our performance.
Which of the following 11 behavioral biases do you suffer from? (Spoiler alert: We all fall prey to every one of them, because, well, we’re human.)
- Confirmation bias makes us seek out information that confirms our preconceptions, while we discount contrary facts.
- Framing makes us draw different conclusions from the same factual information, depending on how that information is presented to us.
- Anchoring makes us rely heavily on the first piece of information we encountered when making our investment decisions.
- Hindsight bias is our tendency, after the fact, to regard past events as something we’d actually predicted.
- Availability bias makes us more influenced by events that are emotionally charged and most easily remembered.
- The bandwagon effect, also known as herding, occurs when people invest in positions because other investors are acting the same way.
- The illusion of control makes us overestimate our ability to influence a market that is, in fact, mostly random.
- Information bias leads us to seek out irrelevant facts that cannot, in reality, affect our investment outcomes.
- Loss aversion is our tendency to be so worried about suffering an investment reversal that we become paralyzed with indecision (or sell at the worst time).
- Optimism bias is our tendency to engage in unrealistic thinking about the stock market.
- The overconfidence effect leads us to have an excessive amount of certainty that we can predict what will happen in the future.
Shelton is a clinical psychologist who retired from seeing patients about five years ago. The resulting spare time allowed him to put his findings on behavioral finance into book form.
In an interview, he modestly claimed to be only an “amateur investor” — he’s been seriously allocating his own nest egg since 2010 — saying his expertise is in “how people think.” He’s been a member of the American Association of Individual Investors for years, which is how I first met him. (I was president of the Seattle regional chapter of AAII from 2012 through 2019.)
Since behavioral biases cannot be willed away — they’re completely below our conscious control — Shelton’s book recommends following a rules-based “investment model.” Chapter 23 of his work mentions the Mama Bear and Papa Bear formulas from Muscular Portfolios, as well as the near-real-time tables at ETFScreen.com, showing which index funds currently rank well in the two models.
Psychological Barriers to Successful Investing is highly recommended. As a self-published book — in both paperback and Kindle format — it is currently available only at Amazon. Use this link to find the book’s page on the website. (Neither I nor anyone at Publica Press receive any commission if you use this link to purchase something.)
We need more exposés such as Shelton’s to keep us informed about our unconscious, self-defeating behaviors. But for now, we do have at least a small library of reading material by him and several other authorities to help us see the problem.
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About the author: Brian Livingston is a successful dot-com entrepreneur, an award-winning business journalist, a contributor to MarketWatch and StockCharts, and the author of Muscular Portfolios (2018, BenBella Books). He is also the author or co-author of 11 books in the Windows Secrets series (1991–2007, John Wiley & Sons), with over 2.5 million copies sold. From 1986 to 1991, he worked in New York City as the assistant IT manager of UBS Securities; as a consultant for Morgan Guaranty Trust (now JPMorgan Chase); and as technology adviser for Lazard Ltd. He was the weekly Windows columnist for InfoWorld magazine from 1991 to 2003. During portions of that period, he was also a contributing editor of CNET, PC World, eWeek, PC/Computing, Datamation, and Windows magazine. In 2003, he founded the Windows Secrets Newsletter, which grew from zero to 400,000 email subscribers. He served as its editorial director until he sold the business in 2010. He is president emeritus of the Seattle regional chapter of the American Association of Individual Investors (AAII). Stipple illustration by The Wall Street Journal.