Death or (um ... ) Death
Apparently the ancient Babylonians would, at the start of each year, promise to pay off their debts and return stuff that they’d borrowed, like the lawnmower (or, as we would refer to it, the neighbor’s goat). As we saw in On Incentives, Agency and Aqueducts they had good reason to be cautious as the punishment for theft was death. Although, to be fair, the punishment for everything in Ancient Babylonia was death. What they lacked in imagination they made up for in consistency. These days we have less strict incentives to keep to our New Year Resolutions, but would probably find ourselves wealthier if we could stick to a few simple rules. The essence of being a psychologically aware investor is self-control, and what could be less modern and more ancient than that?
Uncertainty in a Modern World
Generally people make two sorts of investing mistakes. Firstly we make mistakes of analysis: we’re busily forecasting in a world in which the future is at best shrouded in uncertainty. We can’t possibly get all decisions correct. Secondly we make psychological mistakes: our minds betray us into making decisions in which the balance of probable outcomes lies against us. And, to compound the issue, we usually ascribe the latter sort of mistake to the former sort of category: we blame the uncertainty of the world for the mistakes of our minds.
There are lots and lots of variants of behavioral bias – I keep The Big List of Behavioral Biases as an amusing aide memoir to the complexity and multiplicity of our ingrained inability to think straight, but there are a few simple things we can do to reduce our error rates and, ultimately, improve our returns. If the Babylonians could do it, I don’t see why we shouldn’t.
So, before we embark on and embrace another year of monetary mayhem, here are a few simple resolutions to guide us on our way:
I Will Not Sell Winners To Buy Losers
Our number one stupid behavior is selling winners to buy losers. This is one of the most famous pieces of research ever done in the area, by Brad Barber and Terrance Odean, and they showed that overwhelmingly the stocks that internet traders sold went on to outperform the ones they purchased to replace them, an outcome of…