Friday, October 5, 2007
John Nofsinger - Psychology of Investing
Investment finance, with all the charts and data and financial models for investing, is highly capable of putting a budding insomniac to sleep, and it wouldn't be too far fetched to say that the job of professors teaching investment is to take something profoundly simple and turn it into a complex maze of jargon and formulas.
If investing is a science, shouldn't every well taught investor with a bloomberg terminal be rich? That's not the way it works. Knowledge, strategy and information is important, but what happens when everyone has access to the same knowledge and information? The human element is what makes the crucial difference.
Professor John R. Nofsinger's courses offer that 'something extra' - A peek into the mind of an investor. He teaches behavioral finance and investor psychology at Washington State University and is the author of a best seller on the subject, The Psychology of Investing.
Education: Ph.D., Finance, Washington State University, 1996
BS, Electrical Engineering, Washington State University, 1988 Education: Ph.D., Finance, Washington State University, 1996
Career: Associate Professor of Finance, Washington State University, 2001-Present
Assistant Professor of Finance, Marquette University, 1996-2001
Editor's Note: If you go through the CV of most finance or economics professors, it starts with money and ends with money. There is almost always no education or experience in technical or manufacturing sectors. People who come to economics from other sectors tend to have a wider understanding of the human element and production processes than economists who have lived in their ivory tower dealing with abstract concepts and numbers all their life. I therefore contacted Prof. Nofsinger to ask him why otherwise sane investors seem incapable of picking up warning signals right in front of their noses just before a market crash. His comments in full, as is and unedited, are published below.
Psychologists have found that as decisions become more difficult and involve higher levels of uncertainty, those decisions tend to be more strongly influenced by emotions and feelings. Investment decisions are difficult and fraught with much uncertainty. People who do not know financial theory and analysis must rely on their psychological biases to help make decisions. Even those who know quantitative investment methods can slip into the use of biases and emotions in their decision-making process.
The human brain often utilizes shortcuts to make decisions quicker and with less effort. One such shortcut, the representativeness bias, projects the characteristics of something that we know onto the characteristics of something that we do not know. One outcome for investors is that they consider past returns to be a good estimate of future returns. Thus, people tend to pour money into assets that have already risen in price. Whether its real estate, tech stocks, or hedge funds, people extrapolating past performance end up buying high. After the price bubble pops and the asset values plummet, these investors sell low. We all know to buy low and sell high. But this bias (and others) influences us to do the opposite!
Fields like psychology are useful to investors and advisors because they help explain why we sometimes make bad investment decisions. Over the past decade, the field of behavioral finance has evolved to consider how personal and social psychology influence financial decisions and the behavior of financial markets. Making decisions through sound financial theory and avoiding biases and emotions will set you on the road to investment success.
That was Professor John R. Nofsinger, Washington State University.
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