Review

Rating: 7

REVIEW FROM AMAZON BY CRAIG MATTESON

What a cool book! Terry Burnham wants to help his readers understand that while we fancy ourselves users of reason and rational beings we still have blind spots in our thinking and behavior that can get us into a great deal of trouble when making investment decisions. That is, unless we are explicitly aware of these problems and consciously work to train ourselves to avoid them and be continuously on guard against falling into their pit.

Burnham organizes the book into four parts. The first chapter is the introduction and presents the gist of the book. What is a mean market? The fact that markets can defy the accepted bromides about rational markets and wipe out investors surprisingly quickly and without any hint of mercy. The idea of cosmological indifference comes to mind. The author’s vivid image of the “Lizard Brain” refers less to any explicit structure in the brain or any claim to specific evolutionary path to brain development.

Instead, Burnham is referring to the fact that we all have a set of tendencies, hard wired ways of perceiving the world, and bred in behavioral tendencies that worked well in keeping our ancestors alive in the ancient world. However, they are as out of place in our technological world as a lizard might be at the Met. For example, our brains are very good in seeing patterns. The problem is we often see patterns where none exist. On the other hand, we are terrible at perceiving frequencies. However, with training and discipline we can learn to deal with both of these natural tendencies. Without being aware of these potential problems, we too often get ourselves in trouble.

The first part weighs the traditional Efficient Market Hypothesis (EMH) of rational markets against the oceans of evidence that people do behave irrationally. Here is where I differ slightly with Burnham. My understanding of EMH does not require that each individual act rationally or that any given price at any instant in time be the “right” price. Instead, it indicates that in the aggregate that most irrationality cancels each other out and resources get allocated surprisingly efficiently. As for prices, the notion is not that the price is free from being too high or too low, but that there is a “right” price at all that will be in the area of most of the trading with some of it too high and some too low.

However, the EMH doesn’t help the investor account for irrationality or how to avoid its dangers in one’s own behavior or capitalize on its existence in others. And this is where the book’s strengths are to be found.

The second part takes us through a survey of evidence of irrationality in the American markets and the limits of growth that are so often ignored in pricing equities. The author also takes us through the uses and perceptions of money, barter, inflation, and deflation. All interesting and useful information.

In part three we get Burnham’s actual views on how to pull all this together in viewing Bonds, Stocks, and Real Estate for investments at the time of this book (2005). Burnham is an economist and discounts the optimism of many people who tout these products. I think he makes a great deal of sense. However, it is up to you to make your own decisions.

Part four provides two chapters full of principles for us to apply in making our own investment decisions. The first chapter gives “timeless advice”. That is, those principles that are applicable in any type of market at any time. The second chapter offers “timely advice”. That is, advice that is market condition specific. Burnham gives us principles to apply in rising or declining markets and how to know when to use them.

The issue is whether we have the discipline to apply them or will we surrender to the emotional pull of the lizard brain and find ourselves in trouble.

Burnham makes this subject quite lively, is able to put some nice color to it with some good anecdotes, illustrative stories, and some actually funny jokes.