The subtitle to chapter four of "The Little Book of Behavioral Investing: How Not to Be Your Own Worst Enemy" is simple and straightforward: “Stop Listening to the Experts!” Author James Montier challenged readers to depend less on people whose information may be more bluster than science.
Do you really believe that?
Montier began with a piece of psychological research that shows we humans are too confident in our abilities. What is really shocking, he adds, is that experts are even worse than amateurs; their confidence levels are too high, and their ideas are wrong too often.
With that he talked about a study that compared the confidence levels and expertise of two groups: weathermen (of both genders, presumably) and doctors. In this research project, weathermen were given weather patterns and asked to make a prediction. Doctors were given case notes and asked for diagnoses.
Weathermen turned out the best results: they thought they would be right 50% of the time, and they were. Frighteningly, doctors thought they would be correct in 90% of cases, but were right only 15% of the time (perhaps that’s part of the reason doctors have a reputation for being poor investors).
Montier attributed the differences as the result of feedback each profession receives. Weathermen get much more feedback and, consequently, give themselves much wider confidence intervals.
About that Jim Cramer guy
Doctors like to sound confident and, fortunately for them, people love people who sound confident. That, speculated Montier, is why the loud and overly confident Jim Cramer has had a place on television.
To back up this line of thought, Montier turned to a research project in which volunteers received cash for accurately estimating the weight of people based on their photographs. The guessers had some help, advisors whom they paid; there were four advisors, with varying degrees of confidence, and the guessers could choose any one of them in each round. As to the results:
“You might think that the guessers would learn to avoid the overconfident advisors. The good news is that the longer the game was played, the more the guessers tended to avoid advisors who had been wrong previously. Unfortunately, this good sense was significantly outweighed by the bias towards confidence. As long as you were wrong but sounded extremely confident, even a poor track record was excused. Such is the power of confidence.”
Montier added that our brains turn off some of our natural defenses when told someone is an expert.
No, you should not do what you are told
Next the author loaded another layer of expert problems: authority. People considered experts also become authority figures. Needless to say, “we tend to blindly follow authority.”
Montier turned to the work on authority by Stanley Milgram in the 1960s. Curious about the willingness of ordinary people to do what they were told by authoritarian leaders in World War II, Milgram created an experiment that turned out truly disturbing results.
Briefly, subjects administered electric shocks to a “learner,” according to the instructions of a “teacher.” The shocks ranged from “slight” through “danger,” "severe shock” and, ultimately, “XXX” on the high side. Actors were the recipients (or supposed recipients) of these shocks and they met with the subjects before each test began.
Subjects would press a button for one of the five shock levels as instructed by the “teacher,” and in response would hear a grunt at the low level, verbal complaints about a heart condition at the second level, a demand to be released at the third level, an agonized scream at the fourth level and only silence (presuming unconsciousness or death) at the fifth level. At each level, a buzzing sound accompanied the supposed shock.
Psychiatrists, according to Montier, predicted that only 1% of subjects would send the maximum shock level, apparently in the belief that Americans would not do that to one another. Reality turned out to be different (in another blow to experts):
- Third level (asking to be released): 100% were willing to administer the shock.
- Fourth level (screams of agony): 80% complied.
- Fifth level (no response): 62% sent the shock, despite warnings of severe danger.
The lesson for investors: be more skeptical of experts and their authority.
Is your fund manager a weatherman or a doctor?
Here’s another blow, courtesy of Montier:
“It is time to turn our attention once again to fund managers. It might be tempting to think that fund managers are more akin to weathermen, but sadly the evidence suggests that investment professionals are the one group of people who make doctors look like they know what they are doing.”
The basis for this claim comes from a study that involved two groups: students and professional investors, with each picking one of a pair of stocks. Skipping through to the results, we see:
- Students: 59% confident in their stock picks with 49% correct.
- Professional investors: 65% confident with 40% correct.
Even more shocking was the finding that when the professionals proclaimed themselves 100% certain about their picks, they turned out to be correct less than 12% of the time.
The problem, according to Montier, is an illusion of knowledge among the professionals, driving overconfidence.
Overconfidence versus Mr. Market
When researchers analyzed 66,000 accounts at a discount brokerage between 1991 and 1996, they discovered:
- The market averaged almost 18% per year.
- Individuals who did the most trading averaged less than 12% per year.
- Individuals with the lowest portfolio turnover earned almost 18% after fees.
Montier concluded:
“Any informational advantage that high turnover individuals had was more than eradicated by the costs of trading.”
Breaking down the figures also revealed that men traded more frequently than women, arguably because of greater optimism and confidence. Not surprisingly, women generated higher net returns than men.
And he arrives at this generalization:
“So if we can’t outsmart everyone else, how on earth can we invest? The good news is that we don’t need to outsmart everyone else. We need to stick to our investment discipline, ignore the actions of others, and stop listening to the so-called experts.”
Conclusion
The question of why we listen to experts is a good one. Montier attempted to answer it by looking at the overconfidence and overoptimism displayed by the experts, as well as the reasons regular people turn to and trust them.
As we have seen in earlier chapters, there continues to be an interesting mix of traits that connect followers with leaders (and experts).
A key takeaway from the chapter is we should have a healthy skepticism about experts, especially those who loudly proclaim their knowledge. In fact, what the overconfident may possess is an illusion of knowledge.
Finally, if you're looking for investment success, it may be best to turn to the women of the family.
About Montier
The author is a member of the asset-allocation team at GMO, the firm founded by Jeremy Grantham (Trades, Portfolio) in 1977. According to his Amazon profile, he was previously co-head of Global Strategy at Société Générale (XPAR:GLE, Financial). The author of three books, he is also a visiting fellow at the University of Durham and a fellow of the Royal Society of Arts. The book we are discussing was published in 2010.
(This article is one in a series of chapter-by-chapter reviews. To read more, and reviews of other important investing books, go to this page.)
