Invest when you are rational—this is all James Montier says in The Little Book of Behavioral Investing. So why should you spend money to know the obvious? Wouldn't it exemplify the irrationality that Montier cautions you against? Perhaps not.
The mind is a wily agent and doesn't notify you before acting unreasonably. Worse, it impersonates logic while surreptitiously behaving illogically. Without the ability to distinguish between the rational and the irrational, your best intentions to follow Montier's advice are doomed to fail.
This is where the real value of the book lies—in helping you identify how perceptions masquerade as knowledge, impulses as ability and a cluster of details as the big picture. For once, the destination is known and, therefore unimportant, while the road to it is.
To fulfil this objective, Montier considers common investor reactions to problems and breaks down the thought process, which is dominated by what he calls the mind's X system (emotional section). So the decision to bail out before a predicted market crash seems to be logically consistent. Till Montier points out that the assumption on which it is based, the accuracy of the forecast, is not validated.
All predictions have an element of uncertainty. Yet, if a series of experts spout the same thing on 'bubblevision' (Montier's definition of a TV) with a background of demonic numbers, the future seems crystal clear. Neuroscientists have discovered that when investors listen to economists, the section of the mind dealing with valuation and probability weightage becomes activated, while the process of self-analysis becomes somewhat paralysed.
Unfortunately, experts are more often wrong than right. In 2008, they had expected the stocks to rise by an average of 24 per cent; instead, they tanked by 40 per cent.
This is how Montier exposes the chinks in arguments that are beguilingly logical. His presentation of the mind's machinations is delightful, flush with anecdotes, puzzles, quotes from psychologists and numerous scientific experiments.
However, he never digresses from juxtaposing the rational with the unreasonable. This is a clever narrative technique because the contrast helps Montier present the solution alongside the problem. This makes the book more compact, and the style, more crisp.
It also overcomes a challenge inherent in the content. Montier holds the reader's mind culpable for his financial failures, thereby creating psychological resistance to adopting his solutions. By ensuring that the learnings are implicit in the contrast, he conveys his message in a way that the readers don't have to confront this resistance at all.
Though the mental pitfalls enumerated in the book are ponderous, the strategies to overcome them may seem flimsy. This is the mind's trick, not Montier's failing. Going back to the example of misleading experts, the most effective, though simple, solution is to avoid listening to them on television. Instead, investors must concentrate on their own market research. The only defence against irrationality is to develop processes that the mind is trained to follow.
From the perspective of behavioural finance, Montier's work is hardly avant garde. Isolated from their context (which adds maximum value to the content), the psychological concepts are not extensively fleshed out. Hence, the book cannot be used as a reference for loss aversion, immediacy effect, and so on.
However, it manages to carve a niche by exploring the mind's complex logic algorithm in an easy, effervescent style. Read it not to transform yourself into a rational machine overnight, but to question decisions, financial and otherwise, that may have become axioms in your life. The pursuit of the elusive and illusory logic starts with this small step.
The emotional and rational contrast
The X system
The C system