What role does psychology play in investing?

Morgan Housel's 'The Psychology of Money' book is having a moment right now, it's been optioned for a movie and it's selling faster than semi-d's in Mullingar at peak Celtic Tiger (you know the time when people would pitch a tent to line in wait for houses so they didn't miss out because prices were only going one way..anyway I digress).

His book is a fascinating look at the role of psychology and behaviours in investing.

I personally find it fascinating how some of the wealthier people I know are very low key, don't drive flash cars and when I talk to them are invested in unsexy but stable assets that they leave to compound away. While I see those who don't have a pot to piss doing very much the opposite replete with outrageous car and spending habits to rival P Flynn.

Contrasting fortunes

Housel brings this very much to life in the contrasting lives of Grace Groner and Richard Fuscone, one was a secretary on a modest salary, the other an Ivy League attending, former Merrill Lynch chairman and Wall Street titan who retired very early to pursue charitable interests (he had that much cash to burn!).

Groner left $7m in her will when she died, Fuscone went bankrupt in 2010. Groner invested a very modest sum in the 30's and left it to compound. According to Housel ''Groner clearly understood patience. She understood frugality. She understood the value of a long-term view and how to not panic -- if only subconsciously.'' Fuscone it appears may have lived much larger and expensively.

Cost Avoidance Syndrome

He also talks about cost avoidance syndrome, about how we as humans when faced with a number of options will do our utmost to avoid any downside but want all the benefit. In the world of finance he talks about how a high return will encompass volatility but we are humans will seek to generate the high return and often try and circumvent the volatility and this can take the form of trades, rotations, hedges, arbitrages and leverage.

He says that ''The true cost of investing -- or anything with money -- is rarely the financial fee that is easy to see and measure. It’s the emotional and physical price demanded by markets that are pretty efficient.

Monster Beverage stock rose 211,000% from 1995 to 2016. But it lost more than half its value on five separate occasions during that time. That is an enormous psychological price to pay. Buffett made $90 billion. But he did it by reading SEC filings 12 hours a day for 70 years, often at the expense of paying attention to his family. Here too, a hidden cost.''

'Anchored to your own history bias'

Housel also highlights that your personal experiences in investing are only a tiny fraction of what has occurred in the world but for you or I they are what we dictate our investments by. I know it'll be a long time before I ever go near a bank share again but just because Anglo turned out to be a basket case doesn't mean there aren't other undervalued bank shares around.

As he describes ''If you were born in 1970 the stock market went up 10-fold adjusted for inflation in your teens and 20s -- your young impressionable years when you were learning baseline knowledge about how investing and the economy work. If you were born in 1950, the same market went exactly nowhere in your teens and 20s.''

Risks of social proof

Housel talks about the 'risks of attachment to social proof in a field that demands contrarian thinking to achieve above-average results.' He describes how popularity is often inversely correlated with opportunity.

You get outsized returns from a stocks valuation increasing in multiples, this isn't going to happen if the stock is already at peak. You are relying on a stock getting more popular in the future.

''High stakes entail risks of being wrong and losing money. Losing money is emotional. And the desire to avoid being wrong is best countered by surrounding yourself with people who agree with you.

Social proof is powerful. Someone else agreeing with you is like evidence of being right that doesn’t have to prove itself with facts.''

He discusses how real contrarianism and going against the crowd requires a very strong stomach and it is when your views are ''so uncomfortable and belittled that they cause you to second guess whether they’re right.''.

Morgan Housel has got a tonne more fascinating insights on the impact of our behaviour on how we invest and he'll be talking through some of these at Smart Money Live at the end of April. You can find out more on this here.