‘The Anxious Investor’ Review: Trading With a Cool Head

The Wall Street Journal

July 11, 2022

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By Daniel Rasmussen

The public is awash with books that treat finance as a science—from how-to manuals that offer a system for judging companies to dense treatises that identify statistical patterns or market inefficiencies. Lost in this sea of text is the fact that markets, ultimately, are made by people. In “The Anxious Investor,” options expert Scott Nations argues that the key to investing well, to borrow a hockey maxim, is to play the man, not the puck.

“Passions and emotions remain the most important aspect of investing,” Mr. Nations writes. “Learning about, understanding, and accounting for your own behavioral quirks can do more to improve your long-term investing results than even a roaring bull market can.”

Bear markets present a psychological challenge for investors. Losing money is about twice as painful as making money is pleasant—a phenomenon known as loss aversion. Investors typically sell when stocks go down, seeking to limit further losses. The result, Mr. Nations shows, is a tendency to “buy into bubbles and sell into crashes.” Investors sold off equities throughout the 2008 financial crisis, especially near the absolute bottom in March 2009. The decision to sell stocks during major downturns, Mr. Nations argues, is one of the worst habits of the investment community.

Mr. Nations’s last book, “A History of the United States in Five Crashes,” was a narrative history of Wall Street’s greatest panics. He has studied the math and history of market volatility, and his new book focuses on the psychology that drives it. Humans are social animals, and when their peers are selling and newspapers are full of panicky headlines about financial collapse, it’s extremely difficult to resist. “Herding is particularly dangerous on the downside of a bear market or stock market crash when the ability to think independently is simultaneously elusive and crucial,” Mr. Nations writes. The rational option, he says, is to be a contrarian during major market dislocations, even if most people prefer the comfort of the herd to making risky solo stands.

“The Anxious Investor” weaves the latest behavioral finance studies into an engaging narrative history that probes investor behavior during the South Sea Bubble of 1720, the tech boom of the late 1990s and the financial crisis of 2008. The author describes the various emotional pitfalls that can make sticking to an investment strategy difficult.

Overconfidence is one of the most significant challenges. Meteorologists make a high volume of forecasts, get immediate feedback on accuracy and can clearly measure their results. The same is true of horse-race handicappers. But investing is different. “The best investors trade infrequently; feedback can require years; and even then, ‘success’ is a subjective measure.” Investor confidence tends to correlate with recent performance, which usually has no predictive power over future results. Still, those on winning streaks become overconfident and take on more risk, while those on losing streaks focus on risk management and caution.

“None of the behavioral biases that humans display when investing—not a single one—generates better returns or minimizes risk,” Mr. Nations writes. To make better decisions, investors need to understand and overcome their instincts. He lays out what he believes is the simplest path to follow to achieve better results: buy and hold for the long term; invest primarily in broad-based index funds; and refrain from checking your portfolio too often lest you be tempted to act.

Those who check their portfolios often tend to take too little risk; they prefer cash and fixed income to equities despite the better returns offered by stocks. These investors also tend to trade more often. One study Mr. Nations cites found that investors who traded infrequently achieved returns that matched the market, but the quintile of investors who traded the most lagged the market by about 7% per year. Those who do less earn more.

The economist Robert Shiller wrote that investing in speculative assets is a social activity and that investors “spend a substantial part of their leisure time discussing investments, reading about investments, or gossiping about others’ successes or failures in investing.” Mr. Nations argues that we’d be better off avoiding these social aspects of investing. Presumably reading books about investing or following financial experts on Twitter doesn’t cross the line.

With the equity and fixed-income markets off to a rough start in 2022, investors might do well to review the lessons shared in Mr. Nations’s book—and to try to conquer the anxiety that volatility can create even for the most seasoned and thoughtful financiers.

Mr. Rasmussen is the founding partner of the hedge fund Verdad Advisers.

Appeared in the July 6, 2022, print edition as 'Trading With a Cool Head'.

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