Feel Lucky Punk?
The fact that others are biased does not justify your disagreeing with them, if you have no reason to think you are much less biased. Via Brad DeLong, from a 2002 Fortune article by Justin Fox on "Is The Market Rational? No, say the experts. But neither are you–so don’t go thinking you can outsmart it:
The dirty little secret of the behavioralists is that, for all their work on investor irrationality and market anomalies, they still believe that markets work pretty well and that trying to outguess the collective wisdom of millions of investors is usually futile…. But efficient-markets theory has a dirty little secret, too, which is that for the market to remain efficient, there have to be lots of rational investors who believe enough in the market’s inefficiency to spend their careers trying to beat it….
The argument of modern behavioralists includes a crucial observation that wasn’t in Keynes–that professional investors are now under so much pressure from their customers that they cannot make the kind of long-term bets that might beat the market. If they do, as was the case with a lot of value-oriented mutual funds in the late 1990s, they can soon find themselves without any customers’ money to invest. That gets us to a world in which an investor with enough staying power and contrarian gumption can beat the market, but the vast majority of mutual funds and hedge funds don’t. In other words, the behavioralists have reconciled the success of a Warren Buffett (which efficient-markets purists have absurdly termed dumb luck) with the overwhelmingly empirical evidence that most professional money managers fail to beat the market.
This is, we posit, a major intellectual accomplishment. What does it mean for you? That’s easy: Buy and hold. Diversify. Put your money in index funds. Pay attention to the one thing you can control–costs–and keep them as low as possible.
Two points before this scrolls off (I have been out of town and computer free).
Buffett makes long term bets, and the proportion of investment firms that are "value-oriented" rather than "growth-oriented" has increased since the 2000 crash.
Buffett also does something few can do, obtain inside information. He has the resources to do so, which most of us lack. So, reportedly before he makes one of his long term investments he does serious in-depth investigations of the firm in question, well beyond what one can get by public information. I have heard that this has gotten even as far as having paid sources hang out in executive washrooms to pick up on inside gossip, and similar such stunts. Of course someone who can afford to get better info than almost anyone else can make bets that will consistently beat the market. It is the average slob listening to TV and radio financial talk shows who has little chance of doing so.
I disagree with this claim:"professional investors are now under so much pressure from their customers that they cannot make the kind of long-term bets that might beat the market"Calling mutual fund managers "professional investors" reflects confusion about what they're paid for. Few mutual fund investors are able to recognize managers who can beat the market (if many did, the relevant inefficiencies would vanish), so there's no reason to expect those managers to be expert at anything better than implementing their customers' strategies.Also, the implication that investors need longer-term bets is misleading. I doubt that investors who beat the market make significantly longer-term bets than others.
The basic message of this article is right - the average investor would do better by acting as if markets are efficient.Does this mean that adopting false beliefs about market efficiency constitutes a good cognitive bias? I see strong signs that more people are able to adopt such beliefs than are able to produce the equivalent results by rationally overcoming their overconfidence biases. But I hesitate to recommend such false beliefs because I doubt that people can combine false beliefs in market efficiency with a commitment to truth elsewhere where it's needed.