A random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing

WHAT ARE THE LESSONS FOR
INVESTORS FROM BEHAVIORAL
FINANCE?
Night owls like myself often watch the late-night TV shows.

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One of the funnier bits from David Letterman’s show is the
segment “Stupid Pet Tricks,” where pet owners have their
animals perform all manner of dumb antics. Unfortunately,
investors often act very much like the owners and pets on the
TV show—and it isn’t funny. They are overconfident, get
trampled by the herd, harbor illusions of control, and refuse
to recognize their investment mistakes. The pets actually
look smart in comparison.
We have just seen how various aspects of human behavior
influence investing. In investing, we are often our worst
enemy. As Pogo put it, “We have met the enemy and it is
us.” An understanding of how vulnerable we are to our own
psychology can help us avoid the stupid investor delusions
that can screw up our financial security. There is an old adage
about the game of poker: If you sit down at the table and
can’t figure out who the sucker is, get up and leave because
it’s you. These insights about investor psychology can keep
you from being the patsy.
Charles Ellis, a longtime observer of stock markets and
author of the brilliant investing book 
Winning the Loser’s
Game
, observes that, in the game of amateur tennis, most
points are won not by adroit plays on your part but rather

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by mistakes on the part of your opponent. So it is in
investing. Ellis argues that most investors beat themselves by
engaging in mistaken stock-market strategies rather than
accepting the passive buy-and-hold indexing approach
recommended in this book. The way most investors behave,
the stock market becomes a loser’s game.
How easy it was in early 2000, when the tech stock you
bought moved persistently higher, to convince yourself that
you were an investment genius. How easy it was then to
convince yourself that chasing the last period’s best-
performing mutual fund was a sure strategy for success. And
for the few who gave up their jobs during the bubble to
engage in day-trading, how exhilarating it was to buy a stock
at 10:00 a.m. and find that it had risen 10 percent by noon.
All of these strategies ended in disaster. Frequent traders
invariably earn lower returns than steady buy-and-hold
investors.
The first step in dealing with the pernicious effects of our
behavioral foibles is to recognize them. Bow to the wisdom of
the market. Just as the tennis amateur who simply tries to
return the ball with no fancy moves is the one who usually
wins, so does the investor who simply buys and holds a

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diversified portfolio comprising all of the stocks that trade in
the market. Don’t be your own worst enemy: Avoid stupid
investor tricks. Here are the most important insights from
behavioral finance.