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Try This Experiment Yourself...
Submitted by Tim Price via Sovereign Man blog,
James Montier’s bible on behavioural finance, ‘Behavioural investing’, points out two recent discoveries by neuroscientists that have relevance to all investors:
1) We are hard-wired to think short-term, not long-term
2) We also seem to be hard-wired to confirm to the herd mentality
A particularly intriguing experiment used by Montier to illustrate these points relates to our tendency towards ‘anchoring’.
In his words, anchoring is “our tendency to grab hold of irrelevant and often subliminal inputs in the face of uncertainty.”
Feel free to follow the experiment yourself:
1. Write down the last four digits of your telephone number.
2. Is the number of physicians in London higher or lower than this number?
3. What is your best guess as to the number of physicians in London?
The idea of this experiment is to see whether respondents are influenced by their phone number while estimating the number of doctors in London. The results of the experiment can be seen below:
As the chart indicates, respondents with last-four telephone digits above 7-0-0-0 suggested, on average, that there were just over 8,000 doctors in London. Those with telephone digits below 3-0-0-0 suggested 4,000 doctors.
As Montier concludes, “This represents a very clear difference of opinion driven by the fact that investors are using their telephone numbers, albeit subconsciously, as inputs into their forecast.”
So our thesis goes as follows. In the absence of reliable knowledge about the future, investors have a tendency to anchor onto something – anything – to help them predict future market returns.
And what better anchor to use for future market returns than prior ones?
This is where the story gets more intriguing.
When looking at the UK stock market in discrete 20-year blocks, the period from 1980-1999 is the only one in the last 300-years in which inflation-adjusted returns averaged between 8% and 10% per year.
We think the story gets more intriguing still, because a good part of those returns was somewhat illusory in nature.
More specifically, given that they occurred during a once-in-a-century period of extraordinary credit creation, those market returns were in large part borrowed from the future.
This is the same way that governments have been funded, and their colossal bond markets serviced– by essentially loading the ultimate cost and the final reckoning onto the next generation.
So it seems that investors are not anchoring their predictions of future market returns to the past, because, as the data shows, long-term real returns have been quite low.
Instead, investors are anchoring their predictions to the very recent past that they have direct experience with, i.e. the twenty-year period between 1980 and 1999, even though this period was an anomaly compared to the last 300-years.
If this thesis is even half correct, investors piling into stocks now on the premise of recapturing some of those 8% – 10% real annual returns, are being at least somewhat delusional.
The credit bubble has burst. Messily. The stock market has not necessarily woken up to the fact. This does not detract from the sensible analysis of equity market opportunities.
But for any investment, its most important characteristic is its starting valuation. Buy attractive equities at sufficiently undemanding multiples and you should rightly expect to do well.
Investors, however, seem to be anchoring their market predictions to recent returns of the past, therefore buying ‘the index’ expensively, inclusive of a grotesque bubble of credit. One can expect this to end in a train wreck.
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Why do they recommend stocks and bonds? A: Commissions!
Why don't they recommend Precious Metals bullion or Real Property? A: No commission.
Actually my bank sells gold & silver and makes a commision. It's only $10 per order vs the starting trading fee of $29/trade so naturally the bias is to encourage trading, not stacking.
How come they never explain that owning a BOND is a form of being a slave owner?
Here's the "telephone number" experiemnt:
Skip to 14:55:
PBS NOVA: Mind Over Moneyhttp://www.youtube.com/watch?v=fYXD-_AMstQ
Spoiler: read article first
There are 37,043 doctors licensed to practice in London as of 2009 (I'm aware the actual number is not the point of the article).
I wonder how my answers would fare, in that experiment:
1- can't be arsed to remember or look it up;
2- no idea;
3- none;
Probably the same reason banks in Quebec do not refer to a "mortgage" because the 2 merged words are only too obvious en Français.
Let me take a shot at it with my rusty high school French: Death choke? Death gag? Death guarantee?
p.s. Anyone ever notice that (using some litarary license by JK Rowling), Voldemort = Voll de Mort = Full of Death?
Vol de mort: flight of death
http://translate.google.com/#en/fr/death%20pledge
"gage de mort"
Thank you Meelion. I had never before thought about the similarity between taking out a mortgage, and visiting a pawnbroker!
Anchoring is also a technique for NLP to create, or insert (where one is asked for if only it matches subconscious criteria) an anchor to promote a view or action.
This has implications far beyond prediction, right down to preferences of every sort, biases of every sort and suggestions of every sort, including pure emotion.
NLP is powerful stuff & easily abused by those who understand it.
This may be going out on a limb here but I'd suggest it's not "the recent past" that's promoted or latched onto directly, just a consequence of the real anchors.
I think the real anchors - disagree please if I can be properly corrected - are a combination of "all right answers are easy answers" and "all right answers come from experts with paper in frames on their office wall" - regardless of performance, evidence, experience or suspicion of fraud that may be appropriate in various situations
I've noticed that every tornado story this week inserts the statement that "scientists don't know whether or not global warming has had any effect on the tornadoes." So, while they aren't promoting the view, they keep raising the question in order to anchor it to observed phenomena.
Neuro Linguistic Programming - yes, dangerous stuff.
Some say it is a pseudoscience and quackery, probably people with paper in frames.
I call it targeted propaganda; any number of examples on financial programs with investment managers saying "investors are crazy to not be buying equities" and "they have missed out on the biggest rally in history" and "this market is just going up" or "the economy is recovering" when they damn well know it's a bunch of bullshit to sucker people in for another crash.
I learned about it in something called "speed seduction". Since learning it I've only found it most beneficial in understanding politics & finance.
Go figure.
I suppose if I was a used car salesman or an insurance salesman that also would help, but I'm not.
Another reason not to watch TV...
It wasn't on TV. The main Internet practitioner of this also went by the name Tyler Durden and did speed-seduction tutorials, shove you into a bar with him & "experts" observing and make you go try to pick up, evaluate what you did wrong, keep sending you back & they'd do it themselves too. Or anywhere, grocery store, whatever. They did the picking up thing like how those in Fight Club picked fights withs strangers in the movie.
Meelion Dollar bonus, Ebworthen, Thank for your comments, what is your opinion on "discriptive Video" it is becoming very common on MSM, I feel it is some kind of conditioning technique but as yet I cannot discern exactly what it is designed to achieve. Any opinions please?
Get a copy of Danial Kahneman's "Thinking fast and slow" to understand how your intuitive system leads to predictable bias. He covers anchoring extensively, and many other things that make us suseptable to all sorts of techniques, including propaganda.
Audiobook >> Thinking, Fast and Slow - Daniel KahnemanPrint >> Thinking, Fast and Slow (2011) -Mantesh
Way late on the thread but from what I can find, descriptive video is for the vision impaired (the blind).
The equivalent for those with vision would be the "sound bite" or the 15 second commercial.
Substantive content filtered down to what they want you to hear or see.
Newer generations are being conditioned to not be able to digest complex content and ideas.
Why would my mother, teacher, doctor, policeman, friend, wife, lawyer, banker, legislator, neighbor, lie to me??
Anchoring is essentially lazy thinking. I don't mean this in a bad way. We all seek shortcuts in our thought processes. Basically we latch onto an answer that seems okay at first thought and go with it. In the absence of better information our thinking process grabs an answer and we go forward with it. When someone has good information on a subject anchoring does not occur. Lacking good information the thinking ( of maybe I should say nonthinking) process latches onto an easy answer.
BTW: my favorite question to test anchoring is how many countries are in africa. Try using the last two numbers in your phone number as an anchor for that one.
Good information today can be stale or wrong tomorrow.
I think the key is a lazy mind doesn't look for newer, better information, maybe never validates any at all.
A good mind will question everything, reasoning over time what questions are reasonable to repeat upon all information, prioritizing as to what can be left till later, so it may get stale but it may not matter much in those cases, and still survive well.
Being 100% sure of how many countries are in Africa for sure would send me to Google. Isn't Sudan now splitting into North & South? I'm not sure if they're done yet, what else will stop / support that activity and that certainly changes the answer.
I am anchoring myself to Gold, Silver, and lead because of their past performance. The winds of craziness are strong, but the metals are heavy anchors. I feel pretty damn safe.
At least I won't have to prostitute myself for a ham sandwich like those poor bastards in Greece.
G&S also double as anchor to your boat at bottom of lake.
No ham sandwich for you, only prostitution. Your anchor is Idolatrous...........
Sweet! I love experimenting with myself; or is that TMI?
The UK stock market changes quite a lot as well as opposed to the Dow Jones. so comparing the FTSE 100 for today to say 2 years and looking at 5 or 10 years ago you will find a lot of companies going in and out or staying out of the index altogether.
Yet another way to manipulate!
All I want to know is how many doctors there are in London now. My phone number ends with 0002 and i guess 29k
great article
I call bs on the stock returns showed here. The distribution doesn't make sense.
Come now, Winston, we all need to know sometimes 2 plus 2 equals five
Bernanke is showing disgust with the fiscal drag and the lack of growth policies. The Fed is and has been pulling their weight but can only do so much - money printing without growth is a recipe for disaster.
Force the markets down with the intent of forcing Washington's hand to doing something much more far reaching than the detrimental effects of Obama(don't)Care and maybe the Fed can begin their exit as they should.
We need growth, not bubbly asset inflation. Ben is blaming Washington imo.
Michelle,
NO ONE has growth policies. And, no, tax cuts are not "growth" policies. The wealthy play the casino; the poor buy from the People's Republic of China.
"The theory of perspectives" By Kahneman
Did the Titanic have an anchor?
I'll guess it had two.
Do markets erode models?
http://www.sciencemag.org/content/340/6133/707/suppl/DC2
Transcript:
http://www.sciencemag.org/content/suppl/2013/05/09/340.6133.766-b.DC1/Sc...
"So what we do in the experiment is we show that markets have a tendency to erode moral
values. The way we find this out is we contrast decisions taken in what we call a nonmarket
condition, if you like, with decisions taken in markets. In the market and the nonmarket
condition, subjects could trade off money and life, in our case the life of mice, so
these are moral consequences. And what we show is that in markets, many more mice
die for a given monetary amount compared to a non-market conditions. And we show
that in a causal way, markets actually lead to the erosion of moral values."