According to the Corporate Finance Institute, Behavioral Finance Theory is based on the premise that individual investors commit errors of knowledge, make emotional decisions, and are influenced by social pressure. They also claim that Traditional Finance Theory is based on rational markets and investors, that neither are confused by errors of knowledge, and investors have perfect self-control. The technical term both theories is Hooey.
Regarding the distribution of knowledge, of course it is not even, and the acquisition of knowledge depends on the motivation each individual. However, it is NOT irrational to act on principles rooted in the best knowledge one possesses. Instead, it is irrational to evade new and relevant information or act on principles one knows to be flawed.
Problems arise when the emotions of the subconscious mind are programmed by irrational ideas that randomly accumulate in someone’s conscious mind.
Accordingly, the efficacy of any philosophy depends on its starting point. At Poetic Justice Capital, we begin with each investor living the one life they have with confidence. By design, it is also one of America’s self-evident truths – the natural right to pursue happiness. To be successful, it is productive work that delivers happiness – the emotional reward for the attainment of material values. While rational principles for thought and action are the cause, none of this is easy.
For example, the elation experienced by ice hockey coach Herb Brooks after his college kids won the gold medal at the 1980 Olympics is impossible to imagine. He had challenged himself with a seemingly impossible task, and to succeed, he adopted the mindset of an entrepreneur. We know his vision, the calculated risk was a game strategy dominated by offense, avoiding mistakes meant player selection, and success required their 100% commitment to this new team, not the tribalism of college rivalries.
For clients of Poetic Justice Capital, emotional rewards are defined by the facts and values of each investor, and then reduced to terms that can be measured – dollars of future wealth. To be objective, the investment strategy decision must be integrated with the enjoyment to be earned through productive work and rational investing.
After the pursuit of happiness is the principle that wealth is produced by man’s capacity to think. Next is Say’s Law – production creates its own demand; then markets – the efficient allocation of resources; and finally money – the tool of honorable trade. All of this requires the economic freedom of property rights and the moral recognition of profits, not the tribalism of socially responsible investing.
At Poetic Justice Capital, the challenge is for advisors and their investors to also think like an entrepreneur. The vision is the spiritual rewards attached to the gain of material values. Calculated risk means that investors will increase risk exposure when it helps satisfy their ambitions. The mistakes to avoid include listening to behavioral finance experts. People and markets should not be reduced to animal instincts; independent lives of motion and purpose are possible, and real.