It may be a mere co-incidence or accidental turn of events that the theme, concept, content, genre and approach of two generically different kinds of books can have so much of close association. In order to appreciate this feature, an analytical study of the following two books was made.
1: Technical Book:
- Description: A supplement for undergraduate and Graduate Investments Courses.
- Publisher: Prentice Hall, 5th Edition (January 8, 2013)
- Language: English
- Paperback: 160 Pages
2. Non-fiction Book
- Publisher: W.W. Norton & Company
- Contents: 213 pages
- Language: English
3. Article 1
- Published: Wall Street Journal on September 18, 2008
- Co-Authors: John Hilsenarth, Serena NG, and Damain Paletta
4. Article 2
- Published: Wall Street Journal on September 13, 2013
- Co-Authors: Kelley Greene, Liam Pleven, Laura Saunders, Dawn Wotapka & Jason Zweio
Investing is parting with one’s financial possession with an expectation of higher financial return. Possessing or acquiring something is the basic human impulse because basically, human being is selfish. Investing being antonymous to possessing, it is always associated with ‘greed’ and the in-built ‘fear’. Thus, psychology plays an important role in investment decision. There have been myriad of books elucidating financial aspects of investment; the Cost-Benefit aspect and the financial risks involved in it. A number of tools are used for decision taking, such as asset pricing models, portfolio theories, and option pricing. The book, The Psychological of Investing is a novel approach to the concept of investment. It narrates the behavioral approach of investors, the reason and cause behind such behavior, its impact on their health and the remedial measures.
Psychology in investing theory plays important role than financial theory. The book describes about psychological biases, which when overcome, aids in correct investment and consequent increase in wealth. After describing the psychological biases in line with everyday behavior, the book makes use of academic studies for showing that there are real problems for the investors.
The book contains 12 chapters under the following titles; 1) Psychology & Finance, 2) Overconfidence, 3) Pride and regret, 4) Risk Perception, 5) Decision Frames, 6) Mental Accounting, 7) Forming Portfolios, 8) Representativeness and Familiarity, 9) Social Interaction and Investing, 10) Emotion and Investment Decisions, 11) Self-Control and Decision Making, 12) Psychology in the Mortgage Crisis. New sections and sub-sections added in the fifth edition are Buying Back Stock Previously Sold, Who is overconfident, Nature or Nurture?, Preferred Risk Habitat, Market Impacts, Language and Reference Point Adaption.
Travels in the New Third World are a non-fiction book written by Michael Lewis. He is a travel writer. Through his travelogue, he takes readers to various destinations around the world, that were worst affected by the fiscal tsunami of 2008. The destinations are Greece, Iceland and Ireland. Cheap credit available prior to the disaster led to the disaster. It was the collapse of the investment bank, Lehman Brothers Holdings that led to the shutdown or takeover of many reputed financial institutions and the meltdown of the stock and housing market. The government provided hundreds of billions of dollars for bailing out of financial firms. But according a U.S Treasury report, $19.2 trillion household wealth was lost and 8.8 million people lost their jobs. Such an unforeseen eventuality has left people with a fundament question ‘how to manage finance?’ that needs to be satisfactorily replied.
The destinations are Greece, Iceland and Ireland. Cheap credit available prior to the disaster led to the disaster. It was the collapse of the investment bank, Lehman Brothers Holdings that led to the shutdown or takeover of many reputed financial institutions and the meltdown of the stock and housing market. The government provided hundreds of billions of dollars for bailing out of financial firms. But according a U.S Treasury report, $19.2 trillion household wealth was lost and 8.8 million people lost their jobs. Such an unforeseen eventuality has left people with a fundament question ‘how to manage finance?’ that needs to be satisfactorily replied.
Michael Lewis narrates in his book, that the exoneration of $ 400 billion debt for Greece might lead regional destabilization of economy. For this reason, Germany, the largest economy of the Euro zone is reluctant to bailout other countries, considered indolent and irresponsible. He blames the European leaders for deliberately delaying the process of bailing out Greece, Ireland, Portugal, Spain, Italy and even France. Such disastrous situation arose because of ‘utter folly and madness’ that grabbed both sides of the Atlantic during the last decade. Individuals, institutions and entire nations, without bothering to know the consequences, accepted outright gratification over long-term planning. A common sense too would not permit to do so. Here is where the element of ‘greed’ plays a vital role and the ‘psychology of investing’, if understood properly would have saved the world from a financial tsunami that rocked the whole world economy.
Prior to the economic meltdown of 2008, British investors were enticed by the prospect of an annual return of 14% per annum. As a result, $30 billion was ‘invested’ in dubious Icelandic banks. Out of this, $28 billion were from companies and individuals and the balance from pension funds, hospitals, universities and other institutions. Oxford University had $50 million. Property related losses in Ireland were to the extent of 106 billion euros. A handful of Irish politicians and bankers had ‘decided’ to guarantee all the debts of the biggest Irish banks. Here, chapter 5 of “Psychology of Investing” titled Decision frames; read along with chapter 7, titled Emotion and Investment decision would have been of much guidance to the guarantors.
After making a comparative reading of both the technical and non-fictional book, it becomes evident that the theme is the same ‘Investment’. The non-fiction book makes people aware of the disastrous effects of wrong decisions taken under the grip of perverse ‘psychology’ of making easy and high return, without giving consideration to the existing state of affairs and its long term consequences. On the contrary, the technical book, Psychology of Investing, with 12 well-laid down chapters, systematically describes every psychological aspect that is likely to impact the investment decision. It’s a kind of bible for all kinds of investors because besides guiding them on positive aspects of investment, it restrains them from taking such decisions that may lead to financial collapse.
In order to further study references have been made to the two articles as mentioned above. The Financial crisis of 2008 has taught basic lessons to investors to keep themselves safe and strong against any eventuality of financial disaster.
First, the article titled ‘What we learned from the financial crises’ has been taken up. It is written that Ms Evans says she follows the advice of his 89 year old father that ‘you have not lost it until you’ve sold it’. So focus on stocks that pay dividends and diversifying your portfolio. Sequence risk is the big danger that big losses early in retirement can upset your plan to live off your investments. For hedging sequence risk, you should have enough cash in hand for covering at least a year’s worth of basic expenses such as food, housing, health care and transportation.
Another way for hedging risk is rebalancing. Richard Sylla, a professor of economics at New York University advises that investors should select the percentage of their portfolios with which they are comfortable to allot to stocks and bonds and return to that balance on a regular basis. This calls for discipline.
Lance Gunkel, Chief Operating Officer at Sherpa Investment management in West Des Moines, Iowa advises to review the investment objectives and risk tolerance at least once a year. This ensures that your strategy is appropriate. You may take advice of your investment advisor regarding your tolerance for risk. He should recommend gradual tax-efficient steps like reduction of your exposure incrementally, allocating new money into investment involving lower risk and for building up your cash reserves. Avoid a sharp and sudden overhaul of your account. Avoid taking any drastic or evasive or defensive action. Determine your comfortable level of risk and set realistic expectations for future returns.
You can ‘harvest on your losses’ by selling an investment that has dropped down in value, realizing a loss and repurchase the holding soon after 31 days, as prescribed by tax laws. Losses on the sale of holding can offset other capital gains or they can cover ordinary income up to $ 3,000 a year or both. If the loss exceeds that, it can be carried over for future use, without any limitation. Mr Smetters says, the biggest benefit of ‘loss harvesting’ is mostly psychological because it gives investors a sense of ‘control’.
Janet Tavakoli who runs Tavakoli Structural Finance, a consulting firm in Chicago advises investors to have a simple response if a product or company appears too complex and difficult to comprehend. In fact, the opposite of this is evidenced. Investors siphon billions of dollars into that track the investments like master limited partnerships and floating rate loans, which can’t be comprehended well. Therefore, Warren Buffett advises to invest in business that one understands well. In 1999, he advised to rely upon the ordinary human virtues such as common sense, thrift, pragmatic expectations, patience, persistence and perseverance. These characters are apt to be rewarded in the long run.
The article of Jon Hilsenarth indicates the emergence of new fault lines, beyond the original problem, in the post-crisis period. They are troubled sub-prime mortgages in such areas like credit-default swaps, the credit insurance contracts sold by American International Group Inc. The health of the trading partners too is in doubt.
As against the earlier expectations, the impact of the crisis is going to continue for long. Anne Mulchay, Chief Executive of Xerox Corp warns; it is going to last a lot longer than anticipated. Fed and Treasury officials have identified the disease as ‘deleveraging’ that involves unwinding of debt. During the period of credit boom, financial institutions and American households took too much debt. During the period 2002 and 2006, household borrowings grew at an average annual rate of 11% that far outpaced the overall economic growth. It was 10% for the financial institutions. Now those borrowers are unable to pay back the loans, resulted in the collapse of the housing prices.
The real estate boom of 2000 was encouraged by Wall Street. Consequently, the mortgage loans too were encouraged, that included predatory sub-prime mortgages with camouflaged fees and ballooning rates of interest. That was to get more cash into the casinos. Thereafter, the financial firms and banks offered complex investment opportunities for large investor to buy and sell and also ‘bet’ in a number of ways. Banks collected heavy fees with every trade and transaction. Besides, the banks had their own betting.
As against the earlier expectations, the impact of the crisis is going to continue for long. Anne Mulchay, Chief Executive of Xerox Corp warns; it is going to last a lot longer than anticipated. Fed and Treasury officials have identified the disease as ‘deleveraging’ that involves unwinding of debt. During the period of credit boom, financial institutions and American households took too much debt. During the period 2002 and 2006, household borrowings grew at an average annual rate of 11% that far outpaced the overall economic growth. It was 10% for the financial institutions. Now those borrowers are unable to pay back the loans, resulted in the collapse of the housing prices.
With the active support of congressional Democrats and that of then presidential candidate, Barrack Obama, the Bush administration put together the $ 700 billion Troubled Asset Relief Program (TARP) with the authority given to the Treasury Department for taking over the bad debts and pump in cash into the major financial institutions. Even after the Obama administration took over, the same Federal Reserve officials continued with the same programs. It was expected that the TARP would be able to lend money to finance new investments. But the opposite happened. Banks and other institutions tightened up on every form of credit.
There are 3 ways of ending the deleveraging process; firstly the financial institutions and others should rectify their mistakes by wring down the values of their respective distressed assets. Secondly, they must pay the debts and finally, rebuild their eroded capital cushion. Selling of distressed assets create a downward spiral. It pushes down the prices of assets, which in turn make them difficult to sell more assets. Consequently, the share prices of the firms get suppressed and it becomes harder for the firms to raise capital by selling new shares. Mr. Bernanke christens this process as ‘financial accelerator’.
An analytical review of the above two books, read with the related articles reveals that both the technical book and the non-fictional book are ‘must to be read’ books for established investors and the prospective ones. All human activities, whether financial or non-financial, are propelled by human psychology. The instinctive human urges such as fear, greed, whim, over confidence are all negative forces that need to be handled carefully before taking any action. And if the decision is related to investment involving ‘risk’ the guidelines given in the book ‘Psychology of Investment’ will be of immense help.
After going through the non-fictional book, ‘Travels in the New Third World’, an obvious anxiety arises as to find out the ways and means of confronting such unforeseen financial disasters that are quite likely to be faced by every kind of investors; individual, institutional, large, small, first timer, novice or experienced and addicted. The best solutions to their investment problems, to a great extent will be solved if the guidelines in the ‘Psychology in Investing’ are adopted along with the conventional financial tools. The essence however is ‘discipline’.
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Bibliography
Greene, Kelley, et al. "What we learned from the Financial Crisis." Wall Street Journal (2013): 25-32.
Hilsenarth, John, Serena NG and Damain Paletta. "Worst Crisis since ’30, with No End yet in Sight." Wall Street Journal (2008): 13-25.
Lewis, Michael. Travels in the New Third World. New York: W.W. Norton & Company, 2012.
Nofsinger, John. Psychology of Investing. Washington: Prentice Hall, 2013.
