Investing Psychology Chapter 5: Hormones and Hedges (Part 2)
Picking up from Part 1 of Chapter 5. We know the institutions are playing a different game. Now let’s look at the actual humans running the show and why their biology might be messing with your money.
Feminine Finance
Data consistently shows that women make better investors than men. Why? Because they trade less and they’re less overconfident.
Men are often driven by dopamine—the “reward” hormone. We get a kick out of the anticipation of a win, which leads us to take stupid risks just for the thrill. Women, on average, are more level-headed and less likely to treat the stock market like a casino. If you want a safe pair of hands, look for a female fund manager.
Marriage and Money
Here’s a weird one: married fund managers take fewer risks than single ones. It turns out that single men (biologically speaking) take more aggressive risks to “show off” and attract a mate.
This “mating dance” doesn’t stop when they get to Wall Street. Single CEOs and fund managers pursue more aggressive, idiosyncratic risks. If you want someone to manage your life savings, you probably want someone whose “risky” days are behind them.
Muddled Models
The finance industry loves mathematical models like Black-Scholes. They make everything look scientific and safe. But as the 2008 crash proved, these models are only as good as their programmers.
The problem is reflexivity. As soon as everyone starts using a model, the market changes because of the model. These models often fail exactly when you need them most—during a crisis. If an advisor can’t explain their “proprietary model” in plain English, walk away.
CEO Pay: The Alignment Lie
We’re told that giving CEOs stock options “aligns” them with shareholders. In reality, it just incentivizes them to manipulate earnings to hit short-term targets.
CEOs with heavy option packages are more likely to engage in “vaguely foul” (but often legal) accounting tricks to pump the stock price right before their options vest. They aren’t running the company for you; they’re running it for their own payday.
7 Key Takeaways from Chapter 5
- Mutual funds manipulate data. Watch out for survivorship bias.
- Indexing isn’t a panacea. Diversify your passive holdings.
- Short-term trading is rigged. Leave it to the high-frequency machines.
- Forecasters are seers. Don’t trust anyone who claims to predict the future.
- Dopamine is a danger. Investing shouldn’t be “exciting.”
- Experience beats youth. Older, stable managers are usually safer.
- Models aren’t reality. Don’t put your faith in a black box.
In Chapter 6, we’ll look at Debiasing—how to actually fix some of these mental glitches.