Lesson #5: Do Not Open Your Mutual Fund
In the closing credits of Austin Powers, Mike Myers in the title role is
seen taking pictures of minx-like Vanessa (played by Elizabeth Hurley).
As he takes photo after photo, Powers snaps his fingers while saying,
â€śignore this, ignore this, ignore me doing this.â€ť The joke is that it is even
Timeless Advice 253
harder to ignore his snapping fingers when instructed to do so. In the con-
text of photography, this little trick helps keep the model at ease and
When it comes to investing, our inability to ignore extraneous infor-
mation costs us money. With modern media and technology it is possible
to get almost instantaneous information. Financial networks in the form
of CNBC and Bloomberg TV allow everyone to keep up with breaking
news. It is even possible for individual investors to listen in on some
companiesâ€™ earnings calls, right along with Wall Street professionals.
In earlier eras it took a long time for information to reach investors.
Consider, for example, the effect of the battle of Waterloo on British
financial markets in 1815. Early reports of the battle suggested that
Napoleon was winning, and this caused the British markets to fall pre-
While the market was plummeting and sellers were panicking, Nathan
Meyer Rothschild was calmly buying. Several days later, the news of
Napoleonâ€™s defeat reached London and markets soared. This netted
Rothschild some handy gains.14
What made Rothschild buy when others sold? He had advance infor-
mation provided via the unlikely route of trained carrier pigeons that flew
across the English Channel. Thus Rothschild got word of the French
defeat several days ahead of others and was able to make a financial
Can we all be Rothschilds by watching CNBC and listening in on
earnings calls? The answer for most people is no. In spite of regulations
making it harder for firms to release information selectively, by the time
news is available to most people, it is too late to make profitable trades.
â€śWake up will you, pal? If youâ€™re not inside, youâ€™re outside.â€ť So says
Gordon Gekko (played by Michael Douglas) to Bud Fox (Charlie
Sheenâ€™s character) in Wall Street. Only those on the inside can trade
profitably on news; if you are not sure if you are on the inside, then you
254 Profiting from the New Science of Irrationality
The worst thing people can do is try to trade on news. Perhaps the sec-
ond worst thing we can do is to even listen to that news. People find it dif-
ficult to ignore information.
A famous experiment by Professors Kahneman and Tversky shows the
effect of useless information on analysis. In the experiment, people were
asked to estimate the percentage of African countries in the United
Nations. Before their guess, a random number was generatedâ€”in front
of the participantsâ€”by the spin of a roulette-like wheel. If people were
rational, the useless information from a random spin of a wheel would
not alter their analysis. In fact, the people in this study were not able to
ignore the information. Those people who saw a high number on the
wheel had higher guesses for the percentage of African countries in the
U.N. than those who saw low numbers on the wheel.15
We are influenced by irrelevant information. This â€śanchoringâ€ť effect
has been demonstrated in many different experiments. Anchoring, for
example, is one good reason to make the first offer in a negotiation. No
matter how absurd that first number, it often influences the final out-
Have you ever made a losing trade because of some talking head on
TV, even when you disagreed with the analysis? If so, you know how
hard it is to ignore a message, and how costly listening can be.
Ignoring the news on the TV is one solid suggestion. It might even be
useful to not open your own mutual fund statements. There is evidence
that the more frequently people look at their investing performance, the
worse they do.16 When we see losses, we tend to make emotional deci-
sions to exit positions. As weâ€™ve learned most trades are bad ideas, and
emotional trades are the worst.
For those who canâ€™t ignore information, the answer is to avoid it. A
simple rule is to align your rate of information acquisition with your trad-
ing horizon. If you are a day trader, then by all means have the TV on and
watch streaming, real-time stock quotes. If, however, you are going to
make a few, unemotional adjustments to your portfolio per year, then I
suggest that you avoid as much information as possible.
Timeless Advice 255
I suspect that an investor, who just read annual reports, or even a
farmerâ€™s almanac, would do better than one plugged into nightly confer-
ence calls of corporate earnings.
Conclusion: Keep your financial news flow consistent with your decision
time frame. As much as possible, turn off the TV during the day, and
donâ€™t look at your portfolio.
Lesson #6: Spin Control for Yourself
Nassim Nicholas Taleb, my friend, and the author of Fooled by Random-
ness, tells a story about one of his former clients. A Swiss firm hired Nas-
simâ€™s firm to put on a hedged position. The trade involved one Swiss
investment paired with a non-Swiss investment.
The bet went on for some time, and it was very profitable. The clients,
however, were not happy. They were making money overall, but the gain
came by making more on the non-Swiss investment than they were los-
ing on the Swiss investment. In cartoon terms, the payoff to the trade
Swiss investment LOSS
Non-Swiss investment GAIN
Seeing the loss, particularly on the Swiss investment, ate away at the
clients. Nassim tried to explain that the important thing was to make
money overall. Nothing worked to assuage the clients until Nassim
started just reporting the position as:
256 Profiting from the New Science of Irrationality
Now the client didnâ€™t have to see that offensive â€śLOSSâ€ť and was
happy. This may seem silly, but Professor Richard Thaler has shown that
most people exhibit some form of this irrationality in what he calls men-
tal accounting.17 We might, for example, be willing to borrow money on
our credit cards at 18% while keeping a savings account that earns 2%. A
rational investor wouldnâ€™t keep such separate accounts, but rather would
pay off the credit card debt with money in the savings account.
Even when there are no real accounts, people tend to keep separate
mental accounts for their money, and this can create costly irrationalities.
For example, I was out one evening shopping with Patricia. She found
some costly cosmetic cream at the swanky store called Sephora. The
cream cost $135 for a small tube.
â€śAre you going to buy the cream?â€ť I asked. Patricia said yes, but then
added â€śIâ€™ve spent too much money today. Iâ€™ll come back tomorrow
morning and buy it.â€ť Patricia kept a mental account for each dayâ€™s spend-
ing. This informal accounting system caused her to spend extra time, use
extra gas, and pay an additional parking fee to acquire what she could
have purchased immediately.
Like all people, I tend to maintain mental accounts, and it has hurt my
investment performance. Beginning in early 2002, I started buying stock
in some gold mining companies. I thought that the Federal Reserveâ€™s
easy money policy might lead to a rise in gold prices, which in turn
would increase the profits of gold mining companies. Accordingly, I
invested a small amount in these stocks.
How did I do on my gold investment? Since my initial purchase, the
price of gold has risen by more than 50%, and many gold mining stocks
have doubled. So I was absolutely correct with my decision to buy gold.
Unfortunately, I made absolutely zero on my investment.
Why did my trading so completely fail my analysis? The answer was
that I was buying gold stocks in an account that had nothing else in it
except for some inflation-protected bonds. Gold mining stocks can be
pretty volatile. So whenever gold declined, I saw this account shrink dra-
matically in value. This made me feel like an idiot, and I tended to sell the
stocks at exactly the wrong time.
Timeless Advice 257
I was suffering from a form of mental accounting. Gold is a hedge
against inflation. Most of us will be far better off in a world where gold
prices are low. So in periods when gold was dropping, my prospects were
improving. When gold went down in price, my overall position looked
Gold investment LOSS
Non-gold investments GAIN
So I should have been happy when gold went down. The solution for
me is the same as the solution for Nassimâ€™s clients. I now make sure that
I look at my overall position. In the past, I had tended to look at each
account separately. Now I force myself to use financial software to look
at my total position.
So the lesson is we need to perform some â€śspin controlâ€ť even for our-
selves. We have to guard against goading our lizard brain to become
active (and destructive). That means we should anticipate what sort of
information would push us toward emotional decisions.
Conclusion: Look at your financial position in an aggregate fashion. In
particular, be sure to combine any defensive positions with other invest-
ments that are being protected.
Lesson #7: When to Go â€śAll Inâ€ť
My buddy Chris, the MIT rocket scientist who we met a couple of times,
is a world-class ultimate Frisbee player. This rapidly growing sport com-
bines elements of soccer and American football.
Chris was a key member on the Boston-based team â€śDeath or Gloryâ€ť
(a.k.a. â€śDoGâ€ť) that had a dynastic hold over the sport both in the United
States and internationally for many years. In the world championship in
258 Profiting from the New Science of Irrationality
1996 Chris scored eight goals as DoG defeated Sweden 21-13, with
seven of these goals being almost full field passes; the equivalent of a
â€ślong bombâ€ť in football.
How did Chris become one of the dominant offensive players in the
world? Interestingly, although scoring requires outrunning the defender,
Chrisâ€™s success is not the result of speed. Although Chris is speedy, he
often plays against others who are faster. Somehow he is able to score
consistently on faster defenders and he dominates competitors with equal
I asked Chris his secret. How do you outrun people who are faster than
you? His answer, â€śI maintain the ability to make at least two different
moves. When I get a slight advantage, I commit completely.â€ť
At almost all times, Chris is not running at full speed. Rather, he is
jockeying for position, and carefully watching for an opening. This can
come in some subtle form such as noting that the defender is leaning in
such a way so as to be unable to react to a move in a certain direction. At
that point, Chris is all in, sprinting at full speed.
In contrast, less experienced players are often running hard almost all
the time. They look like they are doing well, but they do not score very
often. These less successful players expend lots of effort and receive lit-
There are some similar themes in investing. Many people tend to be all
in, all the time. By this I mean that they have maximum capital at risk
every day. In fact, the standard advice from Wall Street is to invest most
money in stocks. An investor who follows this advice is fully committed
to a risky course all the time.
In bull markets, being â€śall inâ€ť is very profitable, but problems sur-
face when markets decline. Remember that Chris always maintains at
least two options for his move. In contrast, investors who constantly put
all their money at risk are not in a position to buy more at moments
of irrationally low prices. By being fully committed all the time, inves-
tors remove the ability to buy moreâ€”they no longer have two viable
Timeless Advice 259
Being persistently â€śall inâ€ť financially has costs beyond just missing
buying opportunities. In fact, it increases the likelihood that the lizard
brain will activate precisely at the wrong time. This tends to lead to emo-
tional â€śpuke outsâ€ť where investors sell during buying opportunities.
This suggests that investors should maintain a financial reserve, and
should only rarely and temporarily be â€śall in.â€ť Such an investing philos-
ophy allows one to have the ability to buy or sell at any given time
depending on the conditions.
There are some similar lessons to be drawn from competitive poker.
The World Series of Poker has â€śno-limitâ€ť rules allowing players to go
â€śall inâ€ť at any time. My observation is that there is a systematic differ-
ence between great players and good players related precisely to the
decision of when to be fully committed. The great players tend to go all
in with hands where they have a good chance to win. Other players
seem to more often get trapped into going all in with worse chances
A key to winning at poker is to know when to â€ślay downâ€ť a hand. That
is to quit playing, even with a good hand rather than bet more money. The
great players will sometimes lay down even solid hands. Better to lose a
few dollars and stay in the game. Bad poker players get trapped going all
in when they shouldnâ€™t.
Conclusion: Keep your investment position conservative enough so that
you preserve both options of increased risk or decreased risk should
others panic and present you with an opportunity. Choose the time to go
â€śall inâ€ť carefully and scale down quickly.
Lesson #8: Do Not Get the Key to the Mini Bar