Gerald Ashley: 0:00

Hello and welcome to another edition of Equitile Conversations. My name is Gerald Ashley and, as usual, I'm joined by my friend and colleague, George Cooper, and today we're going to dive into the quite wide and deep topic of human behaviour and how we interact in investment markets, things that we may not even realise, that we're causing problems for ourselves with, and this is the whole area of behavioral economics and, if you want to look at a narrow point, investment biases.

Gerald Ashley: 0:38

So we're going to dive straight into some investment biases and, George, kick off for us please. um

George Cooper: 0:47

Yeah I mean if, if the area has got a problem, it's probably there's far too many of these behavioral biases to to cover in, uh, in one podcast. But I think if we can talk about a few of the really important ones, I think loss aversion is one of the most important. We've got a whole set of aversions. We tend to regret losing a pound or a dollar far more than we enjoy the benefit of gaining the same amount of money, and that changes our behaviour in a few ways, which doesn't tend to make us optimal investors, if you like, and optimal in many other areas of our decision making.

Gerald Ashley: 1:38

It sort of skews our judgment in that I'm thinking if we're in a loss, all we can think about is how we get that loss back.

George Cooper: 1:46

Yes, and I think this loss aversion. It leads into a couple of other behavioral problems that many people have written about. One is regret aversion and how we think about the mistakes we make. So we tend to really regret what's called an active mistake. So if we take a decision, we do something and it goes wrong. That's quite painful for us.

Gerald Ashley: 2:20

Yeah, it really hurts, doesn't it?

George Cooper: 2:21

Yeah. On the other hand, if we fail to make a decision and it goes wrong, we find that somehow less painful and of course we can push it off to some mystery third party, the market or other investors who don't know what they're talking about.

George Cooper: 2:42

in our own opinion, investors who don't know what they're talking about. In our own opinion, yeah. So to put this into a sort of investing analogy though it's not only in investing what it means is if you're holding an investment and you sell it and then afterwards it suddenly goes up, you feel great regret. On the other hand, if you hang on to it and it keeps going down, you don't feel such a big regret and and this is part of the problem that that causes us to sort of sit on the losers for too long we, we can uh, we tend to harvest the flowers and let the weeds grow.

Gerald Ashley: 3:24

Yes, I think many listeners will be familiar with this idea. There's a sort of emotional cycle or, dare one say, roller coaster, and I think of market adages that you're really only at the bottom of a market when everybody is sold, the last ones who've been clinging on all the way down, they throw in the towel, and you know that that's normally when you get the bottom. I mean, that's a simplistic way of looking at it. But there is this roller coaster and, as you say, there's a family of biases. What else would you think ties into the two you've mentioned?

George Cooper: 4:06

Confirmation bias. I think that's the next one that I think is is really important. Um, yeah, I I see it myself in my own behavior, not just in in the investing world, but world, but news reports, all sorts of things it's very difficult to force yourself to read an article if it basically tells you you're wrong, it's almost painful.

George Cooper: 4:38

On the other hand, if the journalist is telling you that yeah, you're right, you're a really smart guy, it's very easy to read that and have your own view reinforced. So sometimes you have to actually challenge yourself and try to discipline yourself to read things that you disagree with.

Gerald Ashley: 5:00

It's part of our makeup that we like sort of praise and support and we don't like challenge often and I can see that completely. Does it go a little deeper in that we maybe put the cart before the horse, in that I have a view and then I hunt around to find everything that supports that view?

George Cooper: 5:23

Oh, yeah, absolutely, find everything that supports that view. Oh yeah, absolutely, I think. And that's um. What's the phrase in um? In politics it's uh, uh, decision made, uh, decision made, evidence collecting, or something like that, where they, they build the policy and then go out and find the evidence to to fit it. And we do that in all sorts of things. You know, we, we say we, we subliminally decide, we like something and then hunt, maybe without even realizing it, hunt for the reasons that that's true and that, oh, that's the right decision.

Gerald Ashley: 6:03

There is a Swedish psychologist called David Ingvar, who is no longer with us, but he conjured up a phrase called memories of the future. And with this let's take something away from financial markets, say you decide you're going to learn to play the piano. So okay, you're going to go and learn to play the piano. So, um, okay, you're going to go and learn to play the piano. Funnily enough, you bump into me and say, oh, I started learning to play the piano last week. And you open the paper and there's loads of articles about why people should take up the piano and all the rest of it. And ingvar says well, so what the hell's going on here? Well, what you're doing is you're subliminally focusing on that news, that information, friends who are doing the same things as you, and this is sometimes a problem in scenario analysis that people start with a scenario at the end and then work back to find, you know, fit, the facts.

George Cooper: 7:02

Yes, fit the facts, yes, um, and then I think there's another. Another thing that it strikes me is it's happening with these biases. So if you think we've got the, the loss aversion bias, which is basically it's our fears, isn't it? It's we, we focus on things that we're frightened of. And then you've got the confirmation bias we like to focus on things that tell us we're right now.

George Cooper: 7:32

It strikes me that, with the advent of social media and twitter or x and the others that have got these algorithms they've got the algorithms are designed to capture our attention, and that means that means they're basically feeding us all the time with stories about things that either we agree with because we'll read it if we agree with it, or things that we're frightened of because we'll read it if we're frightened of it. So so we've got this sort of um polarization process going on through the agreement channel and a paranoia process going on through the uh, the frightened channel, and I think I think it is changing. It's changing society and design, dividing society, and I also think it's changing the way capital markets behave incidentally interesting that you bring this up because it's some sort of self-reinforcing loop here, isn't there?

Gerald Ashley: 8:31

because we have a tendency to say, oh, the algorithms are pointing to me this way or that way, but of course all they're doing is looking at our past behavior and, as you say, sort of reinforcing particular areas. I mean, one of the problems with all this information age and the sort of digitization and use of algorithms and all this information is the lack of serendipity. You don't really go into amazon and browse around very much. I know you can. You can look at the top 20 or 30 books that have been sold last week or whatever. But it's not the same experience of going into a bookshop and just thinking, oh, I didn't think I'd be interested in Roman pottery, but this is an interesting book.

George Cooper: 9:20

Yeah, that's a good analogy. I think you can think of a sort of thought experiment. It's a little bit like if you're on, let's say, the right of politics or the left of politics, and you walk into Waterstones magically. If you're on the right, all of the books are reconfigured to leaning right wing, and if you're on the left, they're all reordered the other way, so you don't get the serendipity of wandering around and picking up something that might, might challenge you.

Gerald Ashley: 9:53

It shows that we're at a very deep level, we're very influenced. Um, it may sort of touch on one of my uh favorite topics, which is the search for certainty. People want to feel certain and, um, I don't think it's too much of a stretch to go back to the hunter-gatherer idea that you know you want that next meal. You, you know you want to be certain you're going to get food, and I think people increasingly view information in that way, and so they they lock on to almost anything. That, as you said, actually feeds these biases.

George Cooper: 10:32

Yeah, I mean the certainty thing. We can see that. We certainly see it in the financial markets, where far more wealth is stored in bonds and fixed income which give fixed income, hence the name, which give fixed income, hence the name. So you've got a relatively good certainty in that market and far less in things like equities and commodities and gold and things like that, which are far less certain on their returns. So yeah, it's all around us this sort of bias.

Gerald Ashley: 11:09

Now it strikes me that there are kind of two elements here. The first one is to I don't know, dare one say, is it a little bit like alcoholism? The first thing you have to do is admit that we are prone to these biases and to be aware of them. I think we all know people who don't view the world, you know, with any grain of uncertainty or doubt, but it seems to me to be quite important. And then, of course, the 64 000 question what the hell do we do all about? You know all of this and, um, that's a very difficult question, I think.

George Cooper: 11:49

It is difficult to deal with these biases For myself. I can only say the I've certainly found studying the literature and the examples in the literature do help make you more aware of your own biases. So at least you can see it in yourself. I can see it, I think I can see it when I'm making these mistakes myself and hopefully that helps reduce them. But I don't think that?

Gerald Ashley: 12:23

Do you think things are amplified rather, in a group, you know we can get group think and you get two or three domineering personalities on a committee and everybody else falls in line. So does? Does all of this actually get heightened?

George Cooper: 12:40

uh, in group situations yes, I, I agree with that very much, gerald. I think humans are for the most part not, uh, not individual decision makers. We most, most humans, in most things effectively crowdsource their, their opinions. You see it in fashions, you see it. I mean, it's what the advertising industry relies on. So, yes, I think in groups you can get a situation where, effectively, the larger the group gets, the less thinking goes on.

Gerald Ashley: 13:27

Yes, because everybody just accepts the consensus and we are now just sliding nicely into the sort of herd mentality which is what we're describing. Yeah, um, number of people think this is what causes um over excitement, um, and then into bubbles. Um, there's the American consulting firm Gartner. Have a curve called the hype curve, which I will try and describe without the aid of the pen and paper for listeners. Essentially, a new technology or a new process or something appears on the scene and excitement is a very strong upward curve. Um, we get the presser on board.

Gerald Ashley: 14:18

Everybody see this as a new magic bullet that's going to solve everything. Inevitably, that thing is delayed or doesn't meet expectations and sort of falls off again until we find a genuine level where it may actually still make sense as a technology or an idea or a process, and then it starts to yeah, starts to take off in a more gentle, normal fashion. Um, I guess we could say that maybe what's going on at the moment with AI? I mean, you can't move now without everybody telling you whatever it is has been designed by AI. Without being unduly cynical, I expect coffee shops will soon be telling us that the precise process of your cappuccino will have been driven by AI. So I just feel that's just an example of hype and herd mentality, and it's difficult to stand against that Because you say, well, hang on a moment, isn't this all overdone? But the thundering herd will continue.

George Cooper: 15:26

Yeah, I mean I've got as in too little is often inefficient and too much is often inefficient.

Gerald Ashley: 15:57

Well, give us a little description here. This is basically marginal returns actually go to zero and then fall away.

George Cooper: 16:04

Well, the Laffer curve was originally used to describe the return on taxation. So if you set your tax rate at zero, obviously the government gets no income. But if the government sets the tax rate at 100 percent, nobody does any work, so they also get no income. So there must be some revenue maximizing point between those two extremes, which which gives you the maximum return. The sort of sweet spot, really. Yeah, the sort of sweet spot. And we're probably already on the right-hand side of the curve in the UK because we're already seeing that the Labour Party's tax rises that have just been brought in seem to be reducing the tax take. So that's the sort of original version of the Laffer curve.

George Cooper: 16:55

I think we can take the same curve and apply it to decision-making in groups, and that is in a small group. You get a robust discussion of opinions and probably a better opinion formation process. But as as n rises, where n's the number of people in the group, you increasingly get herd behavior where most of the people don't bother to think for themselves and just defer to the opinion of the group. So you actually end up with less discussion and the group is sort of collectively less intelligent.

Gerald Ashley: 17:42

There's safety in numbers. Of course, nobody wants to be writing the minority report on a committee, or they like to try and avoid it, and so there is that sort of almost centrifugal force that pulls people to this activity or this behaviour.

George Cooper: 18:00

Yeah, so I would sort of say you know, there's a famous book, the Wisdom of Crowds. I would maybe amend that slightly and say it should be the wisdom of small crowds rather than very large crowds. But you know, that's I think that's a herding behavior is another, is another behavioral problem that we suffer.

Gerald Ashley: 18:28

That is also, I think, being made worse by social media because we've now got huge crowds in a way that we never had before yeah, and I think also where social media is jumps in is maybe one last bias, so we don't carpet bomb people with all these these issues is so-called recency bias.

Gerald Ashley: 18:50

So, oh, look, here's an instant bit of new news. Um, it incredibly important, um, it's much more important than all the information we've been gathering over the last six months. That may or may not be true, but one of the things with technology is the ability now to receive news reports from all around the world almost instantaneously. I mean, we simply didn't used to get eyewitness reports of things happening in south america or far, or the far east in quite the same way, and so there's a lot of unedited stuff. And I suppose what we're saying are we good self editors? Are we good at saying, okay, that bit of data or news is new and significant, but not to throw out you know, the rest that came before, so to speak yeah, I mean all of these things I think are um, are all very present and, and maybe being amplified, there's.

George Cooper: 20:04

There's another I'm having said that there's too many biases, I'll coin another one here, and that's related to what I think you just said, gerald, which is what I call proximity anxiety, and I've noticed.

Gerald Ashley: 20:19

Ah, now that's a new one to me.

George Cooper: 20:20

Yeah, I've noticed this in a few different ways. I've noticed there's a sort of spatial proximity anxiety in that we often tend to see the worst in things that are closest to us relative to things that are more distant. I've noticed this in my friends and colleagues who come from different parts of the world, including myself, who comes from the UK. I tend to be more sceptical about UK companies. My Australian colleagues tend to be more sceptical about Australian companies, my Chinese colleagues more sceptical about Chinese companies. So there's a sort of proximity anxiety there.

Gerald Ashley: 21:15

So we're beating down on the home team and the age-old phrase of far fields are greener. So, you know things are so bad in Britain, let's go to Australia. And your Australian colleague thinks what the hell are you talking about?

George Cooper: 21:28

Yeah. So I think that's an interesting one and I think it creeps into, for example, politics. So you've still got a very vocal crowd that desperately wants to rejoin Europe and have the politicians of the European Union run Britain, the politicians of the European Union run Britain. And I think that's partially a proximity anxiety thing, that we can see the myriad problems in our own political system more clearly than we can in another political system. So it sort of leads to a bias, to wanting to be run from a distance if you like, and of course you're folding in right back at the start.

Gerald Ashley: 22:14

Then confirmation bias. I'm very pro brussels in the so um. Anything that britain isn't doing very well just shows what a disaster it was to leave and we'd be much better off rejoining, and that that can be very heavy confirmation bias in exactly. That's just one example. It could be, could be in lots of areas and we can move away from politics and think about the military and the fact we're always fighting the last war. It seems, as a non-military person, to me slightly surprising that there are voices saying that we should be building up large armored divisions and tank divisions in the british army where, um, despite all the ballyhoo of these tanks going to ukraine, the evidence was they certainly had little or no impact and in many ways were vulnerable against drones. But again, it's maybe loads of data out there and once, past experience makes military types fight the last war, and this must be true in investment as well, I think I think there's a whole podcast to be to be done on the, on the implications of technology and that on that front, yes, um.

George Cooper: 23:32

But I think maybe, as normal, um, we'll sort of start wrapping it up with some discussion of some recommended reading, and this week I want to uh. The book I want to recommend is one of my favorite, uh, investing Behavioral Investing by James Montier.

Gerald Ashley: 23:55

He is a fund manager. Is that right, or was a fund manager?

George Cooper: 23:58

I think he is now, I think he was a strategist and I think him and Albert Edwards used to work together and they were sort of double active, if my memory serves me correctly Both very smart, very insightful guys. But I particularly like to pick out a couple of chapters from this truly enormous book because they're not directly related to investing but they are really quite important sort of life lessons. So the last two chapters of his book chapter 53 and 54, he starts to talk about happiness, what makes us happy and how we can sort of help ourselves with the teachings of behavioral science. Right, and he makes the point that he discusses a classification of different things that we pursue, thinking they're going to make us happy, calls extrinsic pursuits, which is the pursuit of wealth, the pursuit of possessions and the pursuit of fame, where effectively, achievements in that area position us in the social pyramid and we think as we get higher up we're going to be happier.

Gerald Ashley: 25:30

This is sort of signalling our wealth and status and all the rest of it.

George Cooper: 25:35

So you've got that.

Gerald Ashley: 25:35

Ferrari in the drive, or whatever it may be.

George Cooper: 25:39

And then there's the other group, which he calls more intrinsic pursuits experiences personal development and social relationships. Experiences personal development and social relationships. And the point he makes is the first group, the extrinsic ones. They suffer from what he calls hedonic adaption. In other words, you get the Ferrari only to find your neighbour's got a Rolls Royce so it doesn't make you any happier, or it doesn't quite quite.

Gerald Ashley: 26:08

yeah, it doesn't quite do it for some reason yeah.

George Cooper: 26:11

So you're always looking to those above you and and you, as you make progression, as you progress, you change your wants, so you don't feel any happier. And uh, he, he goes on to cite evidence that those they tend to enjoy a different hedonic adaption, a beneficial hedonic adaption. You go on the holiday, you forget the terrible flight and the horrible hotel, but you remember the wonderful meal you had with friends and you forget the bad experiences and remember the wonderful meal you had with friends right and and you forget the bad experiences and remember the good ones so it's almost we're lighting up a different part of the brain.

George Cooper: 27:15

Here there's something yeah, so I I think um his book's worth reading just for those last two chapters. Um very interesting life lessons there. But I also think this to tie it into what we discussed last week about the changing demographics and the aging of society that james montier is is talking about here and we do start to place less evident, less emphasis on material things and more emphasis on experiences, and I I actually see that happening in the world, where you're getting a bigger and bigger spend on travel, tourism issues, things like that relative to goods.

Gerald Ashley: 28:16

So downsizing and going on cruises might have a double effect almost. You haven't got the burden, maybe, of a larger house, or you've got rid of the kids or whatever, and you've got a little bit more. Well, you've certainly got time and hopefully a little bit more money to go and do more experiences. I may not be a cruise, it might be sort of walking the pennine way or whatever it may be, but it's. It's that sort of um sort of wider experience thing seems to be good for us yes, seem to make us happier, so what are you recommending this week, charlotte?

Gerald Ashley: 28:50

well, um, I'm going to lower the tone a bit here, as we've just been talking about happiness, and the book I'm alighted on is called why Most Things Fail Evolution, extinction and Economics. So that's a nice cheerful topic. It's by a very well-known economist, paul Ormerod, who I think was an early founder of Henley Business School and is quite a heavy hitter as an academic. But he's written some really quite straightforward, dare one say, ordinary books on the topic. This is his second or third book and he tends to focus around the idea which I think you and I are probably in the same camp that a lot of economics is sort of shoehorned into formalized models, the equilibrium model, for example, and it doesn't really fit.

Gerald Ashley: 29:52

And a much better template to use is to look at evolutionary theory, to consider that markets are complex animals, complex systems if you like, and they are, and this is where it gets maybe a little bit depressing. They may be inherently unpredictable beyond a certain point. There are so many moving parts and not only are they moving, they don't move in a nice straightforward manner. So he's written. It's a very entertaining book, it's quite an easy read and the title has probably been invented by the publishers rather than making it for a drier topic, but he does make the point that very few companies last more than about 50 to 100 years. There are still one or two constituents of the dow jones industrial average going, but in general things seem to have a natural life and the markets just roll on with the next thing. So it sounds depressing, but actually it's a.

George Cooper: 31:01

It's a very good read I I haven't heard of that one, but I will read it because, um, I think he's a very insightful guy. I think paul omrond is the guy that, uh, originally alerted me to the process of physics envy in economics, which is quite an interesting topic, maybe.

Gerald Ashley: 31:22

Well, this is another one yeah, this is where economists want to create so-called elegant mathematical models that will replicate the outside world. Um, on that note, I'm going to go off and worry about all my biases now and, um, uh, I guess what we're trying to say is it's all about self-awareness and staying balanced, and we all think we're self-aware and balanced, but, um, wish that it was that easy. So, uh, george, thank you for the insights today. Um, and that's this conversation done and dusted, thank you gerald.