Book Review: Psychology of Investing
The two books “Psychology of investment” by John R. Nofsinger and “Boomerang: Travels in the New Third World” by Michael Lewis are much related in the sense that both the two books talk about the possible financial crises caused by poor investment decisions. The poor investment decisions can be as a result of the negative influence by the environment or negative psychological decision. Taking a look at the first book, “Psychology of Investing” by John R. Nofsinger, the book majorly looks at the common investment mistakes that come about due to the investor’s emotional and cognitive weaknesses. Such mistakes can be grouped into two major categories: how investors feel and how investors think. The author tries to examine the psychological influences in the decisions of the investor as well as the social factors that may adversely affect the financial decisions. The author further states that as much as the emotional and cognitive weaknesses affect all individuals, standard or traditional finance tends to ignore such biases since it assumes that individuals normally behave rationally. Financial theory has a central proposition, which states that markets are efficient. Efficiency in this sense implies that the price of every security coincides with its fundamental value if certain investors do mistakes due to frame dependence or biases.
The author says that as much as a case may be made against an efficient market, the available evidence is not able to support the ability or the habit of investors to produce excess returns all the times. This is to mean that as much as the market inefficiencies do exist, they are normally difficult to exploit. The author advises that if the stock prices are quite efficient and taxes and transaction costs are ignored, investors should never harm their wealth if they frequently trade or follow some specific investing strategies. This implies that traditional finance develops in a normative manner. This further means that traditional finance is concerned with a rational solution to any decision problem by forming financial tools and ideas for the kind of behaviors that the investors should adopt. Consequently, traditional finance does not put much focus on the behavior of the investor and its consequences. The book also talks about behavioral finance, which seeks to examine how real people behave in a financial environment and is for that matter, descriptive. Behavioral finance can also be called “open-minded finance” since it promotes rationality in an economy. However, certain agents may at some time behave less rationally. Generally, behavioral finance is the clear application of psychology to financial behaviors. The author states that the proponents of behavioral finance hold onto the idea that individuals may not be “rational” all the times, but they are “human” all the times. Behavioral finance thus exposes the investors’ irrationality in general and also exposes human fallibility in a competitive market.
The author also states that departures from rationality are often systematic although they are sometimes random. He further notes that investors’ deviations from economic rationality may be highly systematic and pervasive. This belief is common with the psychologists who have a strong belief that individuals normally act in an irrational manner and make obvious errors when in a mission to forecast. Behavioral finance relaxes the common assumptions of the traditional finance by including systematic, observable, and human departures from the zone of rationality into the models of financial behavior and markets. The writer argues that by combining finance and psychology, it becomes easier to explain certain features of investor behavior and security markets that seem to appear irrational. Why is it of concern if investors behave differently as required by the traditional finance? The writer elaborates that investors are prone to making specific mistakes of which others may be minor but others are very fatal.
Taking a look at the second book, “Boomerang: Travels in the New Third World”, by Michael Lewis, it majorly focuses on the financial crises in countries like Greece, Ireland, Iceland, and Germany and explores how the countries’ endless financial implosions have caused a great mess in their money and markets. The book captures the aspect of international economic crisis. The author has a humorous way of presenting his ideas and one is often tempted to laugh but again, he talks about very serious economic mistakes that nations make, thereby landing them into financial crisis. As much as Lewis may have a robust sense of humor in all the instances in the book, he is not just a mere satirist; he first seeks to understand a complicated issue before deciding to make fun of it. In the first few paragraphs of the book, the author talks about a banker or a finance minister who gets set up for mismanaging the funds that is supposed to be used to improve the economy. The funds are instead diverted to benefit a few individuals, which eventually puts the country into a state of financial crisis. The writer uses funny and head-scratching judgments and at times uses stereotypes to attack the offending countries. He not only states that countries like Greece, Iceland, and Germany got into financial troubles but also attempts to expose their souls.
The author’s financial disaster tourism started in Iceland where the whole nation has no immediate experience or any slight memory of what high finance is. The author says that from 2003 to 2007, the banking system, real estate sector, and stock market in Iceland all boomed, but that was just an illusion since there was the web of cronyism whereby bankers formed the habit of lending each other huge sums of money to buy stuff like private jets and Beverly Hills condos, at madly inflated prices. Such transactions were among friends since as Lewis states, Iceland was more of one big extended family than a nation. Such activities resulted into a bubble burst making the banks to implode, thereby leaving every Icelander in banking losses of some money amounting to $330,000. The author states that the problem of such a country can be said to be that of national character. During the boom period, the people of Iceland thought they were so special, as seen with the president giving speeches mainly mentioning the nation’s culture, heritage, training, and home market, but they were not in reality. The author makes fun of the country’s financial elites, whom he described as lacking sophistication, and described them as fishermen turned investment bankers. He further mocks the country by saying that the government’s economic team is only made up of veterinarians, philosophers, and poets. He concludes that the men were supposed to leave the women of Island to run the show and saved themselves the shame.
The author then moves to Greece where he a gives a fascinating tale of the individuals given the responsibility to manage the nation’s resources but later turned against the nation and became the poster children of corruption and greed. He talks about a an individual who managed to get the ownership rights of a certain lake and at the same time acquired some government land in a crafty deal that when revealed in the press, left the public outraged. The monks also used the government funds to build a real estate empire at a cost of $1 billion. There were two anonymous whistleblowers who revealed the innate corruption in Greece. The whistleblowers were themselves tax collectors. Lewis states that the Greek officials lied in order to get themselves into the European Union. They did this by doctoring the Greek economic data. He further states that on the day of measuring inflation, the government statisticians involved themselves in acts like removing tomatoes (high priced) from consumer price index and also moving stuff such as defense spending and pensions off the book.
The author states that the Greeks are selfish and insular. They never say anything positive about one another. Lewis states that tax evasion in Greece is like a birthright and civil servants often evade tax and they are actually paid for thirteen to fourteen months in a year. It is a country whereby during elections, the government pulls its tax collectors and the mob prevents ship passengers from spending and disembarking. The author states that the number of individuals involved in the catastrophe facing the country is not only baffling but also ridiculous. The country is composed of old fashioned bankers who takes deposits at 3% and then lend them out at 6% and then head to the golf course at 3 p.m. The author has the notion that the epidemic of cheating, stealing, and lying makes any kind of life impossible. The idea of whether Greece will honor and pay all its debts or choose to default and consequently pull Europe into deeper financial crisis will generally depend on whether it will change its cultures. The writer notes that he is not very optimistic whether Greece can change its culture.
The next country that the author looked into was Ireland, which experienced an economic boom in 2000 when the Irish people were economically very pessimistic. They suddenly discovered economic optimism. During periods of pessimism, it became the first European country to watch as its banking system crumbled. The country had a very long intimate relationship with wretchedness until it moved from being extremely poor to being extremely rich without pausing in the middle to experience normality. This made the country go through a painful moment when the boom period ended. The author’s next stop in the trip was Germany, which was his weirdest analysis as they had very little obsession over their economic boom. During the boom, the Germans did not live beyond their means that may have put them into massive deficits. The citizens did not involve themselves in buying overpriced assets that was beyond their financial capability and the government officials did not rush to make bundles at the investment firms. Lewis however notes that this does not in any way imply that Germany is not to blame for the present financial crisis or that they will not suffer from the impacts of financial crisis. The Germans’ acts of disciplined expenditure made the German banks become major creditors to other European countries that were spendthrift. The author states that Germans did not just believe in excrement but they strongly believed in rules. However, German lost when they bought assets from America thinking that the assets were safe. The Lewis’s book’s incessant stereotyping and moralizing attitude at some point leaves the readers wondering why the author, after travelling throughout Europe, took the path from being a storyteller to an itinerant scold. The book is full of unforgettable scenes and wonderful characters, but at the same time it is preachy, and even exudes anger. This kind of mix is quite distracting.
Looking at the book by Michael Lewis, it depicts the notion that it is normally hard for a country to change its culture and adopt a new one even if the old culture is harmful to the country’s financial or economic performance. This is depicted by Lewis in the Case of Greece where he expresses a significant doubt whether it can change its culture of corruption, stealing, lying and so on, and embrace the German culture, which involved a responsible and a disciplined spending. On the other hand, the book, “psychology of investing” by John R. Nofsinger, describes why it is hard for people recall their past errors. It states that memory is not about recording of past events since memory is an emotional and factual experience that involves factual recording of events. Just like in the book authored by Lewis, Nofsinger in his book states that people normally refuse to change themselves even if they know that they are not right. This comes as a result of self denial and to avoid the uncomfortable scenario whereby the brain would develop a poor self image and a feeling of failure. This makes it hard for people to see and understand their error. People instead avoid going through the pain by ignoring, rejecting, and minimizing any information that conflicts with their positive self image and a feeling of being right. Nofsinger has the notion that one does not gain the experience of being wrong, but people are rather oblivious to such mistakes.
Lewis majorly addresses the problem of corruption, mismanagement of funds by government officials, incompetence of policy makers and economic implementers. At some point in his book, he calls the bankers as fishermen who had changed careers to become bankers. This was only meant to criticize the incompetence of such officials in a humorous manner. He further says that women can even perform better in such positions instead of the clueless men. His major concern here is to call upon such countries to adopt good culture, good manners, and reputable values that would make such countries move from a state of poor performance into a state of high performance. A country that has competent economic and financial expertise enjoys a high economic stability unlike a country that employs corrupt individuals who only concentrate in embezzlement funds. On a similar note, the book “psychology of investment”, by Nofsinger also talks about tolerance and good manners or “the disagreement deficit”. This mainly advocates for cultural norms and values that would make people learn from their mistakes or errors. Nofsinger states that cultural values are very vital since it makes one realize any flaws that may exist in his or her own beliefs and the need to adopt new beliefs or behaviors that may make one make further mistakes in the future. The author further states the importance of tolerance and describes tolerance as the act of shutting up concerning what one believes. However, the author further states that as much as people tend to automatically accept and embrace information from the people they trust, they have the tendency of automatically rejecting information from unfamiliar, confrontational, and disagreeable people.
The book by Lewis also elaborates on the need for an economic and financial stability that can provide a favorable environment for investment. At the same time, the author also emphasizes on the need to handle or solve the problem of financial crisis since investment is not possible in an economy that goes through financial crisis. This made Lewis carry out a tour across several countries and analyzed each country’s economy and their possible contribution to the global financial crisis. Lewis found that different countries have different cultural affiliations and this brings the difference in their different financial behaviors. For example, the author says that the Germans were very cautious on how they spent their finances and never engaged in wasteful spending even during boom periods. This kind of financial discipline of German made its financial institutions become creditors to most European countries which were spendthrift. Lewis states that other countries like Greece were ridiculously corrupt and lacked any economic and financial agenda that would make the country engage in investments. On the other hand, in the book, “psychology of investment” by Nofsinger, the author also discusses the aspect of investment and the things that make individuals shy away from investment. He states that there is the need for formation of committees in various organizations that will look into the investment decisions of such companies. The committees mainly have the mandate to prevent any pitfall that may exist in the organizations and thereby hinder the organization from accomplishing its targets of implementing its investments.
Finally, both the two books talk about belief system and how what people believe can affect their relationship with others and even the performance of the whole economy. Nofsinger tries to explain that the understanding of whether something is right or false has a great impact on people’s beliefs. What digs even deeper into people’s mind is the study of the degree of being right or wrong. He further states that it is advisable for people to identify the false information and be able discard it from their beliefs and remain with that information that is true and valid. The book written by Nofsinger is very important as it tends to make people evaluate their lives and understand that people are different and everybody is entitled to his or her behavior. It also makes people understand why they make mistakes and how people can use their errors to become better people and good decision makers. Lewis on the other hand advocates for good moral standards and rational cultural beliefs that can drive the world to a higher level of economic performance, while at the same time avoiding practices that may drive the economy into financial crisis.
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