Behavioral Finance

The Knowledge of London

“A little learning is a dangerous thing; drink deep, or taste not the Pierian Spring: there shallow draughts intoxicate the brain, and drinking largely sobers us again.”
-Alexander Pope

London has one of the most complex city grids in the world.  A view of the city from above looks as if someone dropped a plate of spaghetti.  Navigating your way around the city as a tourist can be a daunting task (stay on the wrong side of the road), even with a GPS device.

An alternative to finding your own way around would be to hail one of London’s iconic black cabs.  Horse-drawn hackney carriages first appeared in the city during the mid 17th century, which today have morphed into the famous black cabs shown here:

Becoming a London cab driver is an incredibly difficult task, which is known to take 2 – 4 years.  Part of the training involves memorizing no fewer than 320 basic routes, all of the 25,000 streets along those routes, and over 20,000 landmarks.  This is referred to as “The Knowledge”.  The memorization training is so intense that a 2011 study from the University College of London showed the hippocampus (the area of the brain associated with memory) had actually grown in drivers that had completed learning The Knowledge.

In recent years, Uber has invaded the city in an attempt to disrupt the London cab drivers.  Requirements to become an Uber driver are……well much more lax.  Complaints regarding Uber drivers in London have been abundant.  Passengers have voiced irritation that Uber drivers often take more inefficient routes, and they are more focused on their GPS devices than the road itself.

There are also horror stories that range from the dozens of sexual attack accusations against London Uber drivers to one driver accidentally taking off with a baby still in the backseat.

In my last article I discussed the complex landscape of choices that investors are burdened with.  Navigating the world of finance without any guidance can be similar to trying to find your way around London with a paper map.  It can be done, but it may be much less efficient and take more time.

There are many tech startups that have made their way into the finance industry over the last decade, with a similar goal of disrupting the industry.  Some are quite exciting and have even helped enhance the efficiency of financial planners, while others I would argue have been detrimental to a client’s financial success.

For instance, one major startup launched a few years back on the platform of “commission free stock trades”.  People like free things so why pay for each stock trade when you can trade as often as you’d like for free?  This may cause clients to trade more since there is no cost to doing so.  Numerous studies show the more that you trade, the more likely you are to underperform.

A 2000 study by Terrance Odean and Brad Barber which studied over 66,000 households showed that those who traded the most actually underperformed the broad market by 6.5% annually.  If that is the case, then it means there could be a tremendous penalty for actively trading.

How does a company make money that doesn’t charge anything for trading?  One avenue is they encourage investors to buy “on margin”.  This is a strategy where you use borrowed money to buy additional shares.  Typically, if you have $10,000 in your account, you can buy $20,000 worth of stock and pay interest on the $10,000 you borrowed.  Gains and losses are both magnified.  It can get dangerous quickly.

It is important to understand the difference between an investor and a trader.  The latter believes markets do not work and there are inefficiencies to consistently identify and exploit.  The research shows that very few are able to do this over time.

An investor believes markets do work and may choose to passively invest in various dimensions of the markets offering different amounts of risk and expected returns.  This seems to be the minority group.  While data shows that investors are using more passive investment vehicles today, they are still trading them actively.

Getting from point A to point B in London or in markets can be done with a map, or an app, but it may be more efficient, less stressful, and safer to find someone with the knowledge to help.

Any opinions are those of the author and not necessarily those of RJFS or Raymond James.  Investing involves risk and investors may incur a profit or a loss. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material.