If you want to profit from other people’s investing mistakes — and who doesn’t? — make a plan in advance. The brain is stuffed with cognitive biases — errors in thinking, like loss aversion — that undo investors but that, at the same time, create opportunities for others in the market, argues Stephen Duneier, CEO of Bija Advisors, in his book “AlphaBrain” (Wiley- February 2019).
The book provides a proven, systematic method for overcoming flawed, emotional decision-making that’s based on “gut instinct.” In chapters such as “Cerebral Junk Food” and “How to Stop Losing Money,” the veteran investment manager, 51, serves up his cognitive science-based approach with which Bija helps investors reach better outcomes.
ThinkAdvisor recently interviewed Bija senior advisor Jake Vincent, who edited “Alpha Brain” following a severe stroke that Duneier suffered in 2017. He is continuing his recovery in rehabilitation.
Over a 30-year career, Deneier has scored kudos as a dynamic, popular public speaker. One of his motivational TED talks, “How to Achieve Your Most Ambitious Goals,” can be seen on YouTube.
Vincent, previously a hedge fund manager and sell-side strategist at Merrill Lynch and Credit Suisse, has a background in psychology and is a member of the British Psychological Society.
Duneier’s cardinal rule for investors: Don’t be reactive. Instead, be proactive by having a process and a trading plan set in advance, albeit one that’s subject to consistent re-analysis and is continually evolving, he writes.
Duneier started out as a broker with Drexel Burnham, then ran currency options trading at Bank of America and was managing director for emerging markets at AIG International.
Next, he developed a hedge fund into a $1.25 billion fund with average annualized returns of 20.3%. In 2012, he founded Bija consultancy, based in Santa Barbara, California.
The multi-faceted Duneier has raced cars, flown a helicopter, piloted planes acrobatically and is the artist known as YarnBomber, who has created large-scale installation knitted art on Santa Barbara mountain trails.
Here are excerpts of our interview with Vincent, who discussed the investing concepts and advice about which Duneier has written in “AlphaBrain: How a Group of Iconoclasts Are Using Cognitive Science to advance the Business of Alpha Generation”:
THINKADVISOR: Stephen Duneier writes: “We are prone to decision-making mistakes, and it’s those mistakes that make it possible for skill to exist in our industry. The only way to generate true alpha is to capitalize on the mistakes of others.” Please elaborate.
JAKE VINCENT: A lot of opportunity is created by relatively predictable behavior. As investors, we have to understand those mistakes and look for places where other market participants make them.
How can investors avoid making their own decision errors?
By having a plan for exactly how to make decisions, analyzing the outcomes and constantly improving the decision-making process, while taking out emotion and instinctive actions [generated] by the cognitive biases we all hold.
How do these biases — errors in thinking — impede investing success?
The idea is: How do you compensate for the flawed conceptions we make naturally, not thorough some error. It’s just how our brains work. How do we fight that? How do we make sure we don’t repeat them? The answer is: By making a process that constantly fights the errors our brain makes day to day.
How can financial advisors help clients overcome cognitive biases?
The most important message of the book is: Don’t be reactive because you’ll be even more prone to falling into natural cognitive biases. If you’re calm and logical and have a plan set in advance, that plan will be free of emotion.
How can that benefit FAs?
They’re able to say to clients who want to invest in [a certain company], for example: “[This firm] has been on the news a lot, but that doesn’t necessarily mean it’s a good investment. Those are two separate things.” If, say, the market is down 5% and people are calling their advisors: “Get me out!”, the advisor should be ready with a plan to help them. The point is to have a process for going about what kinds of trades you look for, which constantly evolves.
What’s an example?
You’ve analyzed the previous returns and have seen that you have a propensity to do a certain kind of bad trade on a Wednesday. So you put something in place that doesn’t let you trade on Wednesday morning. You’ll have an efficient, fact-checked and constantly re-analyzed process that gets you to constructive trades — and you’ll be disciplined about it.
“When real money is on the line, we are more likely to make worse decisions,” Mr. Duneier writes. Is that because we’re nervous at such times?