Spend much time in the comment sections of stock trading sites such as Motley Fool and Interactive Investor and one thing rapidly becomes clear: investing for many people is about much more than an attempt to secure riches or a retirement income.
For many, it is closer to a leisure activity, a source of excitement and a game to be played. It supplies excitement, variety, and less pleasantly, a sense of intellectual superiority over others.
These are all sources of pleasure that draw people back to the markets and in at least some cases, cause them to spend a large amount of time online monitoring stop losses and posting snarky comments. Surprisingly, though, little research has been done into the emotional drivers of investment.
Investment management ‘is not therapy,’ says Richard Taffler, professor of finance and accounting at the University of Warwick, and one of the pioneers of emotional finance. ‘But therapy is about giving people a safe environment to explore their unconscious, so it may be therapeutic.’
At this point, many sceptics may be trying to contain their sniggers, but Taffler’s work is underpinned by extensive research, directly interviewing 50 managers with an average of 15 years’ experience and about $500 billion under management, and densely referenced to original psychological research.
Much like behavioural finance, while the concepts used can be nebulous, the lessons are rooted in the practical world of how to be a better investor or fund manager.
‘When we think about markets, the traditional words we use to describe them are fear, greed and hope,’ Taffler says. ‘But investment is not really about fear. It is more about anxiety, and a desire for excitement.
‘The managers we interviewed were certainly not greedy, in the dictionary definition of being rapacious, but they were driven by excitement about the stocks they were attached to. [And] it’s not really about hope, but more about denial, denial that you can’t predict the unpredictable.’
Perhaps one of the biggest insights for investment managers is Taffler’s research into what draws people to markets, drawing on research conducted in Finland, which stores a large amount of anonymous data on its citizens, and the relationship between investment and other forms of sensation seeking.
‘Investment is exciting. What the authors discovered was a direct correlation between driving violations, the level of trades and [stock] turnover.
‘Similarly, the higher the fines paid and the greater the speeding violations, the greater the trading activity. Each individual ticket was correlated with something like 7% more trading. Even just owning a sports car offered a correlation.’
He refers to at least one large Swiss institutional and private client manager has already recognised this with the appointment of a ‘speculative investment’ director who provides due diligence of hedge funds that offer something racy, but not too racy.
He even goes as far as proposing a 5% to 10% allocation to a ‘sand pit’ strategy explicitly offering a more speculative, higher risk/return profile, specifically pitched to clients as a source of excitement.
‘Active fund management provides an outlet for these needs within a safer environment. It provides some excitement, with less of the potential to damage wealth.’
Consciously or not, fund houses are already picking up on phenomena most easily understood as aspects of emotional finance, such as Artemis’s ‘profit hunter’ adverts, featuring intrepid explorers in pursuit of an elusive bird-like prey of alpha.
This taps into one of the most widely discernible aspects of emotional finance, the common desire for ‘phantasy objects’ – external projections of unconscious needs and emotions.
Bernie Madoff, dotcom stocks, collateralised debt obligations: all are understandable as objects onto which investors were willing to (temporarily) project their desire for reward without risk.
‘They are all unconscious mental representations of something that meets our earliest desires. The “magic of Madoff” was a term that his investors actually used to describe investing in his funds. Market group thinking helped prevent his discovery.
‘Facebook was so obviously a phantastical object, although sadly I had no way to go short on it. The concept of a phantastical nature is a very useful tool for understanding what people want. People kept on buying dotcom stocks well over the cliff’s edge [of the 2001 crash], because they kept on finding the confirmation they wanted to keep on believing these things were true.’
Fund Management: An Emotional Finance Perspective by Professor David Tuckett and Professor Richard Taffler is available as a free download from the CFA Institute website.