Investing is the Study of Human Behavior

The last couple of days I’ve been talking about interest rates; how they might effect your personal investment decisions, the factors that theoretically determine them, and how we expect people to behave when interest rates are low.

In looking at all this I am struck by how “wrong” the classic supply and demand curves are. (You can see the theoretical relationship between supply of household funds and demand for funds from businesses here, and how, in my mind, they currently look due to “coronavirus” behavior).

Being able to think through the theory of how factors should effect interest rates is useful. But it’s not the whole story.

If investing could be boiled down to only mathematical relationships and formulas, it would be a solved problem.

To play the investing game, I would argue you need juxtapose the formulas with your observations of human behavior.

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(Photo from Mogan Housel's upcoming book: The Psychology of Money)

Investing decisions have to incorporate how people think, how they behave, how people deal with greed, risk, and scarcity. And what people are likely to do next.

Economic relationships and formulas are based on a lot of assumptions about how people should act, not how they actually do. They also suffer from “definition bias,” where the way a metric is defined either leaves out important data, or incorporates a lot of irrelevant data.

If there’s a valid idea in psychology, economics has to recognize it and vice versa.

Investing is the study of both theoretical formulas and human behavior.
Eric Pelnik's avatar
this is why dollar-cost-averaging is so effective...set it and forget it - this helps remove so much of the psychology that negatively impacts peoples' investing habits