5 Universal Laws Of Human (Investment) Stupidity

Tyler Durden's picture

Authored by Lance Roberts via RealInvestmentAdvice.com,

In 1976, a professor of economic history at the University of California, Berkeley published an essay outlining the fundamental laws of a force he perceived as humanity’s greatest existential threat: Stupidity.

Stupid people, Carlo M. Cipolla explained, share several identifying traits:

  • they are abundant,
  • they are irrational, and;
  • they cause problems for others without apparent benefit to themselves

The result is that “stupidity” lowers society’s total well-being and there are no defenses against stupidity. According to Cipolla:

“The only way a society can avoid being crushed by the burden of its idiots is if the non-stupid work even harder to offset the losses of their stupid brethren.”

Let’s take a look at Cipolla’s five basic laws of human stupidity as they apply to investing and the markets today.

Law 1: Always and inevitably everyone underestimates the number of stupid individuals in circulation.

“No matter how many idiots you suspect yourself surrounded by you are invariably low-balling the total.”

In investing, the problem of investor “stupidity” is compounded by a variety of biased assumptions that are made.  Individuals assume that when the media publishes something, the superficial factors like the commentator’s job, education level, or other traits suggest they can’t possibly be stupid. We, therefore, attach credibility to their opinion as long as it confirms our own.

This is called “confirmation bias.”

If we believe the stock market is going to rise, then we tend to only seek out news and information that supports our view. This confirmation bias is a primary driver of the psychological investing cycle of individuals as shown below. I discussed this previously in why “Media Headlines Will Lead You To Ruin.”

As individuals, we want “affirmation” our current thought processes are correct. As human beings, we hate being told we are wrong, so we tend to seek out sources that tell us we are “right.”

This is why it is always important to consider both sides of every debate equally and analyze the data accordingly. Being right and making money are not mutually exclusive.

Law 2: The probability that a certain person be stupid is independent of any other characteristic of that person.

Cipolla posits stupidity is a variable that remains constant across all populations. Every category one can imagine—gender, race, nationality, education level, income—possesses a fixed percentage of stupid people.

When it comes to investing, ALL investors, individual and professionals, are subject to making “stupid” decisions. As I discussed recently:

“At each major market peak throughout history, there has always been something that became “the” subject of speculative investment. Rather it was railroads, real estate, emerging markets, technology stocks or tulip bulbs, the end result was always the same as the rush to get into those markets also led to the rush to get out. Today, the rush to buy “ETF’s” has clearly taken that mantle, as I discussed last week, and as shown in the chart below.”

It isn’t the surge into equity ETF’s which should give rise to concern about future outcomes, but the components of “psychology” behind it.

Though we are often unconscious of the action, humans tend to “go with the crowd.” Much of this behavior relates back to “confirmation” of our decisions but also the need for acceptance. The thought process is rooted in the belief that if “everyone else” is doing something, then if I want to be accepted, I need to do it too.

In life, “conforming” to the norm is socially accepted and in many ways expected. However, in the financial markets, the “herding” behavior is what drives market excesses during advances and declines.

As Howard Marks once stated:

“Resisting – and thereby achieving success as a contrarian – isn’t easy. Things combine to make it difficult; including natural herd tendencies and the pain imposed by being out of step, since momentum invariably makes pro-cyclical actions look correct for a while. (That’s why it’s essential to remember that ‘being too far ahead of your time is indistinguishable from being wrong.’

 

Given the uncertain nature of the future, and thus the difficulty of being confident your position is the right one – especially as price moves against you – it’s challenging to be a lonely contrarian.

Moving against the “herd” is where the most profits are generated by investors in the long term. The difficulty for most individuals, unfortunately, is knowing when to “bet” against those who are being “stupid.”

Law 3. A stupid person is a person who causes losses to another person or to a group of persons while himself deriving no gain and even possibly incurring losses.

Consistent stupidity is the only consistent thing about the stupid. This is what makes stupid people so dangerous. As Cipolla explains:

“Essentially stupid people are dangerous and damaging because reasonable people find it difficult to imagine and understand unreasonable behavior.

Throughout history, investors are constantly drawn into investment strategies promoted by a wide variety of “industry professionals” which ultimately leads to losses in the end. This point was clearly made in a recent article by Jason Zweig entitled: “Whatever You Do, Don’t Read This Column.”

“Investors believe the darnedest things.

 

In one recent survey, wealthy individuals said they expect their portfolios to earn a long-run average of 8.5% annually after inflation. With bonds yielding roughly 2.5%, a typical stock-and-bond portfolio would need stocks to grow at 12.5% annually in order to hit that overall 8.5% target. Net of fees and inflation, that would require approximately doubling the 7% annual gain stocks have produced over the long term.

 

Individuals aren’t the only investors who believe in the improbable. One in six institutional investors, in another survey, projected gains of more than 20% annually on their investments in venture capital — even though such funds, on average, have underperformed the stock market for much of the 2000s.

 

Although almost nothing is impossible in the financial markets, these expectations are so far-fetched they border on fantasy.”

He is absolutely right, and despite the historical realities of investing, both the individual and the professional will ultimately suffer losses. As shown in the chart below, there is no evidence which shows markets can compound high levels of growth rates from current valuation levels. (For more detail on forward returns read “Valuations Matter”)

There is a massive difference between AVERAGE and ACTUAL returns on invested capital. The impact of losses, in any given year, destroys the annualized “compounding” effect of money.

Individuals who experienced either one, or both, of the last two bear markets, now understand the importance of “time” relating to their investment goals. Individuals that were close to retirement in either 2000, or 2007, and failed to navigate the subsequent market draw downs have had to postpone their retirement plans, potentially indefinitely.

But yet despite the losses incurred by both professionals and individuals, just eight short years after the largest financial crisis since the “Great Depression,” individuals are piling on excessive risk once again under the guise “this time is different.” 

Talk about stupid.

Despite the mainstream media’s consistent drivel investors should just “passively index” and forget about actually managing the risk of catastrophic capital loss, the reality is that investors “buy high and sell low” for a reason.

“Greed” and “Fear” are far more powerful in driving our investment decisions versus “Logic” and “Discipline.” 

As Jason states:

“The traditional explanations for believing in an investing tooth fairy who will leave money under your pillow are optimism and overconfidence: Hope springs eternal, and each of us thinks we’re better than the other investors out there.

 

There’s another reason so many investors believe in magic: We can’t handle the truth.”

All of which leads us to:

Law 4: Non-stupid people always underestimate the damaging power of stupid individuals. In particular non-stupid people constantly forget that at all times and places and under any circumstances to deal and/or associate with stupid people always turns out to be a costly mistake.

Lot’s of “non-stupid people” are currently suggesting the next correctionary event will be mild, most likely no more than 20%. The idea is based upon the belief the Federal Reserve, and Central Banks globally, will quickly come to the rescue of a failing market and investors will quickly react by once again jumping back into the market.

However, as we have seen repeatedly throughout history, “stupid” people tend to do exactly the opposite during a crisis than what “non-stupid” people expect.

Then there are the “perennial bulls” who keep telling investors to “hang on, keep putting money in, you’re a long-term investor, right?” These are the ones who never see the bear market destruction until well after the fact and then simply say “well, no one could have seen that coming.” 

Non-stupid people are conservative. They analyze the risk of loss and conserve capital during declines. Make sure you are surrounding yourself with those that understand the “math of loss.” 

As Howard Marks stated above, sometimes being a contrarian is lonely.

When we underestimate the stupid, we do so at our own peril.

This brings us to the fifth and final law:

Law 5: A stupid person is the most dangerous type of person.

Following the “herd,” has always ended badly for investors. In every full-market cycle, there is an inevitable belief “this time is different” for one reason or another.

It isn’t. It has never been. And this time will not be different either.

However, what has always separated out the great investors from everyone else, is they have acted independently of the “herd.” They have a discipline, a strategy and a driving will to succeed.

They don’t “buy and hold.” They buy cheap and sell expensive. They avoid losses at all costs and they deeply understand the relationship of risk to reward.

They are the “non-stupid.”

These are the ones you want to follow.

Not the ones screaming at you on television telling you to “buy, buy, buy.”

Just remember that for every full-market cycle our job is to not only participate in the first-half of the cycle as prices rise, but to avoid the avoid the devastation during the second-half.

“Non-stupid” investors don’t spend a bulk of their time getting back to even.

That is an investing strategy better left to the “herd.”

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Golden Showers's picture

Holy shit this is so true!

Ghost of Porky's picture

If I can just figure out how to monetize stupidity.

knukles's picture

Gotta happily roll in the irony.
A Berkeley professor who is proficient in Stupidity

Brilliant.

Manthong's picture

I think it’s time to jump into some of that there NFLX stock.

I hear that P/E thing is important and the higher the number the better.

So with a 208 P/E it’s gotta be a screaming deal.

AldousHuxley's picture

1) Buy LOW, Sell HIGH

2) Buy the rumor, Sell on the news

3) Buy index funds. .... Wait 30 years.  ...Join the millionare club.

4) Spend less than you earn

5) Don't divorce

BUT most people want it NOW, stock pick on the news, panick sell at lows, buy the hype at highs, spend more than earn to show off to strangers...and have personal vices

 

Buffett is 86, so if you wait even longer after your retirement .....then you can join the multi millionare club....

 

 

ScratInTheHat's picture

Retirement is a modern scam to bleed wealth out of families. You don’t sit back until you have enough wealth to keep your family in wealth for the next generation because that is your FN job! Life is not about you!

Fester's picture

5) Don't get married

Fixeds

Michigander's picture

5) If it fly's, floats, or fucks, rent it.

Really fixed...

ShrNfr's picture

SNAP is a better opportunity, its P/E will always be infinite.

True Blue's picture

Go into the 'student loan' business. Done.

50% of people are *by definition* below average. That makes what; 3.75 billion stupid people on the planet? "...and mankind became stupider at a frightening rate. Some had high hopes that genetic engineering would correct this trend in evolution. But sadly, the greatest minds and resources were focused on conquering hair loss and prolonging erections."

SmackDaddy's picture

Speculating on stocks in the secondary market is not 'investing'.

Investing would be buying something to make some other thing that is useful.

SubjectivObject's picture

I think the psychopath is the most dangerous kind of person.

Maybe masses of stupidos are equivalent to a psychopath with power.

Colonel's picture

"Maybe masses of stupidos are equivalent to a psychopath with power."

 

They are. The results are exactly the same with the exception that the psychopath runs off with the money while the stupido masses are improverished, the dynamic of the stupidos and the psychopaths(bandits in the pdf) have played out for many a millennia of human history, it's so predictable it appears to be the default condition of mankind. To see real-time examples all you have to do is look at lefTARD countries like Venezuela,Nork,Africa, Europe and increasingly the U.S. Basically most of the world.

GRDguy's picture

Agreed:  The 99% are defenseless against the sociopath with no empathy nor conscience.

With no self-defense of mind, body or soul, the sheep are easy pickings by the wolves.

And the biggest problem: They don''t think they need any self-defense.

chosen's picture

I took one of the last classes taught by Carlo Cipolla at UC Berkeley.  It was a graduate class in economic history.  I was the only one in the class.  We met at a cafe instead of a classroom and we talked about my research.  I learned a lot.  Old professors generally end up on the junk heap.  Sort of sad.

Evan Wilson's picture

You were so lucky to be able have an individual class with him. I just read his Wiki online and the UC Berkeley about him. I almost can't beleive that there was no one other student that would not have signed up for the class.

Golden Showers's picture

Dude, I totally understand.

In my case my professors were no-name. They did what they could. One professor would have me over to his house and he'd give me a 40oz and vhs tapes. Kubricks The Killing, The Conversation, Matewan. He'd school me in chess. I tried to teach him GO. We'd sit and shoot the shit. Another professor turned me on to Billington. One got me fascinated with Critical Theory and that bullshit. Little sleeper, that one. Goes off 20 years later in your head like a time bomb. Oh, the Frankfurt school...

We need mentors. Mentors need us. We are each others guides. After so long of sifting through the garbage heap, finding someone with, with enthusiasm (as Robert DeNiro said in some film), is good and rare.

Total upvote for you being where you be and doing what you do.

Thanks! Keep it up!

But I have to say, these 5 things are true. It's not paranoia if one feels that stupid people are a threat to one's well being. It is true that people who are not stupid cover the stupid. I've gotten into so much shit because I don't cover stupid. Then you find that the stupid mentor one another as well. They're a fucking union. Stupid people are a union. Fuck 'em. I hope they all jump off a cliff.

Does society need stupid people? What is the benefit? This article is good at interpreting large herd mentality from some bones. Stupid ultimately brings everything down to it's level. It's a constant battle. It's a grind. Really is. Stupid crushes and destroys potential.

Stupidity is entropy. There's so few of the others who aren't stupid. And that is a major reason why I so appreciate you bastards here. You are not entropic. I guess the only thing that destroys entropy is love and self-respect, and punching people in the face.

Batman11's picture

The prospect of easy money turns human beings into gibbering idiots.

Stocks, house prices, [yet another asset type] are going up in value.

I have heard of someone who has made lots of money, I want in.

I am making money, I need to borrow money to carry on investing and make more money.

Gibber, gibber, gibber ....................................

The bubbles burst; I am going to be ruined.

No more gibbering, till next time.

Tulip bulbs ..... gibber

South sea company .... gibber

UK Railways (1800s) .... gibber

The new internet (pre 1999) .... gibber

Sub-prime ..... gibber

Property .... gibber

BTL ... gibber

Apple .... gibber

Social media .... gibber

Emerging markets ... gibber

Easy money ..... gibber, gibber, gibber

Much more appealing than working for a living.

No wonder the Chinese stock market went crazy.

The typical Chinese experience of Capitalism has been working in an Apple factory with suicide nets.

With the stock market boom, they could make money for nothing and get the true joy of Capitalism.

Riding asset bubbles, its money for nothing.

It's the best part of capitalism; hard work is a fool's game.

aloha_snakbar's picture

Stupid people gather around, I have a new idea that will be sweeping the nation, right after the mudshark...be prepared to throw copious amounts of money at me. A hi-tech, WiFi enabled toilet seat, with a ring of HD cameras and microphones. The minute you raise the lid, you are live. The minute you close the lid, it can upload your video to DeathBook! People have been saying if that toilet seat could talk... well now it CAN!

SnapCrap™... you know you want it...

Grumbleduke's picture

now I have to wipe the bourbon off the keyboard, mate!

ROFL

aloha_snakbar's picture

Think of the possibilities, for apps; Grandma emails and wants to know if you have been eating okay; send her a link...so she can see for herself...she will stop asking in no time. And, since it is connected to the 'internet of things... now your toilet lid can talk to your fridge; had the runs... no problem...your fridge will lock you out of the frozen burritos for a couple of days... problem solved.....

Rainman's picture

The stupids are easy to identify ... all the democrats

English herbsman's picture

I'm pretty sure taking part in the modern markets and "investing" makes you a bumbling idiot... 

Keep your hard earnt cash to yourself and community projects, Fuck the global multinational coporations, They've already stripped you of 1/2 or more your wage through debt, property, monthly billings, energy and food. 

The other half goes to Government which in turn ends up in the hands of multinationals. 

J Pancreas's picture

This reminds me of the Ron Paul picture posted on here years ago of him sitting alone in a large room. In the next pic was Hillary or someone with a crowd around her laughing grotesquely. Anyone have that pics link? I searched and couldnt find it.

Teletubby's picture

" The vast majority of any group, tribe, state, nation, and Empire, are the un-enlightened, and the demise of all these is due this fact."-Aristotle

atlasRocked's picture

THe FED was created becuase most investors are dumb as a box of rocks about scams.

Deep Snorkeler's picture

Thinking takes too much time and effort.

It gets in the way of the immediacy of

pleasurable experiences.

 

I cannot escape the sin of mental laziness.

The_Dead_Bear's picture

 

WE are the herd !

Everyone believes that the market will fall...And yet, it doesn't.

Let's face it : WE ARE THE STUPID PERSONS ... 

Of course, this market will fell, but not today, maybe not this year : there are way too many people expecting it to fall...

           The Dead Bear

 

P.S. How I'd wish I was proven false...

adanata's picture

Trump bought us time; maybe a year, year and a half. The psychos have taken their profits and sold off to mom and pop. I think they were ready to go if Hilda had been in place. As the market fell she could claim, it's not me; I just got here. Trump blindsides them; and could make the same statement with even more credibility, and they must scramble to prop everything back up and make it hold for at least a year as the stupids are convinced all is well. Then they blame Trump and those who elected him for causing economic disaster down the road. I think that's the plan but even the party planners change their decorations to suit current events...

We're not the herd...

ThanksIwillHaveAnother's picture

And the non-stupid must bery VERY pissed at the rigged markets.  Therefore, they are VERY lonely.

Manipuflation's picture

I follow copper long term trends.  Durable goods consume copper.  Durable goods are expensive.  The five year chart is pretty sketchy but a leg up.  Forget the rest of the charts on the link as that is just day to day noise. 

   http://www.kitcometals.com/charts/copper_historical_large.html#5years

Mustafa Kemal's picture

Erwin Rommel had a different take. He said there are two axis. Energy and Intelligence.

There are 4 types of people

stupid and lazy

stupid and hard working

intelligent and lazy

intelligent and hard working.

 

Rommel said that stupid and hard working are dangerous; you need to get rid of them.

As for the remaining. For the 

stupid and lazy; give them menial labor

intelligent and hardworking: make these your staff officers

intelligent and lazy; make these your commanders

SuperRay's picture

Intellectual Yet Idiot.  IYI, as per Taleb.  The most infuriating type of stupid people

brushhog's picture

Think about it...the average IQ is 100, so half the population has a 2 digit IQ. Those people will always be stupid. Then you have people with decent IQ's but who are too young, inexperienced or just dont care....so those people are pretty stupid too. The percentage of people with a respectable IQ, who have the maturity and experience to put it to use are a minority.

slice's picture

Here is the original in PDF:

http://advanced.jhu.edu/wp-content/uploads/2013/07/The-Basic-Laws-of-Hum...

Tomorrow I will be sending my CEO, GM and HR Mgr a copy of the pdf along with our org chart as a cross-reference.

The challenge will be to connect the dots.

Thanks for the article, I will make great use of it!

Able Ape's picture

Buy cheap - it's so simple, a caveman can do it....

Vlad the Inhaler's picture

I just read 8% of Americans score too low in IQ tests to be accepted into the military.

Umh's picture

I'm surprised. I would have quessed closer to 15%. 5% can't find their way back and forth to work everyday particularly if they have to detour for some reason.

Xploregon's picture

So, investing in PM's is....
<--------Not Stupid

<--------Stupid

chosen's picture

I took an undergraduate class at UC Berkeley with Carlo Cipolla.  This one was well attended.  He passed around some old coins.  He said one of his childhood friends started collecting coins and as a result was now very rich.  Cipolla said he wished that he had started collecting coins, instead of pursuing academics.

besnook's picture

unfortunately the bottom half of the class rules the world.we have always been doomed. the timing is the only unknown.

gm_general's picture

Its not enough to be smart to be able to beat the system and get your winnings out in time. You also have to have an objective formula that lets you simulate the behavior of said stupid people en masse. I don't think anyone has come up with such a formula, at least one with repeatable results. The very lack of the ability for stupid people to reason properly and learn from the past may make that impossible.