Why people are so bad at investing

Value investor Jeremy Grantham has come up with a model that explains market booms and busts over nearly 100 years: people are just really bad at investing.

Low interest rates, disruptive new business models, the ongoing impact of globalisation you can come up with plenty of theories as to why share prices are so expensive just now. But well-known value investor Jeremy Grantham has produced an elegantly simple model that explains market booms and busts stretching back for nearly 100 years. His explanation? People are just really bad at investing.

I look at his behavioural model in more detail on this week's strategy page. But it boils down to a very simple observation investors will pay more for stocks when it feels good to do so. When economic conditions are forgiving and companies are making hay, investors are willing to pay a lot more for future earnings from companies. They feel optimistic and comfortable, and this optimism gets priced in to the market.As a result, price/earnings ratios (p/es, which show how much investors are willing to pay for a given £1 of earnings today) are driven higher, and the market gets expensive. But when economic conditions are bad, and companies are struggling to make decent profits, investors get gloomy and scared. They no longer feel comfortable shelling out a lot of money for future earnings. So p/e ratios fall and the market gets cheap.

This is irrational. Economies are cyclical. Good times come and go. But during both good times and bad times, investors act as though high prices will go on forever. They don't "buy low and sell high", as the old, glib stockmarket advice puts it. Instead they buy when prices are high because they think they can only go higher; and they sell when prices are low because they can't see an end to the pain.

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If you fancy yourself a rational investor, you should be able to exploit this. But you will experience some unpleasant emotions. As Howard Marks of Oaktree Capital, another great value investor, wrote in 2014: "Most great investments begin in discomfort bargains are usually found among things that are controversial, that people are pessimistic about, and that have been performing badly of late." One example of an uncomfortable investment right now could be the retail sector in the UK. With Amazon on one side and budget retailers on the other, life is hard for your average shopkeeper. But Phil Oakley sees some bright spots on the high street he looks at the best options in our cover story.

Meanwhile, investors who want to resist their heart's instinctive desire to invest and divest at the worst possible moments should add another bit of classic advice to the "buy low, sell high" clich. During both good times and bad times, it pays to remember: "this too shall pass".

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.