By Jason Zweig | Apr. 3, 2012 7:00 am ET
Image credit: John Maynard Keynes, detail of group photo of Bertrand Russell, Keynes, and Lytton Strachey by Lady Ottoline Morrell (1915), National Portrait Gallery, London
My column this past weekend about the remarkable investing record of John Maynard Keynes provoked an outpouring of comments – and incidentally provided an object lesson on a couple of basic principles from behavioral finance.
Investors succumb to the halo effect when they let their general evaluation of a person or situation cast a warm glow over their assessment of specific aspects of the same person or situation. If you love your iPhone or iPad, you may well love Apple’s stock price, too, no matter how high it might go. Likewise, liberals who admire Keynes’s interventionist economic theories rushed to defend him as an investor.
But Keynes was neither a good nor a bad investor because you agree or disagree with his economic policies. His track record as an investor should be judged just as any other investor’s should be: by the numbers. And, as my column pointed out, Keynes’s investment results were extraordinary – regardless of whether you love his economic theories or you hate them.
Another, related effect: Investors exhibit confirmation bias when they tend to view all new evidence through the old lens of their existing beliefs. They disregard whatever might tend to disprove what they already believe, even while they point eagerly to any information that reinforces the views they already hold.
Thus, several commenters ridiculed the notion that Keynes could have had access to inside information on interest rates and currency values without trading on it. Others insisted that he was front-running his own economic policies, buying gold before he debauched the value of the British pound.
But, to paraphrase Keynes’s friend Bertrand Russell, it’s important to distinguish what you wish were true from what you believe is true.
You may wish that Keynes traded on privileged information, but that doesn’t make it true. There is zero evidence that he ever traded on inside information; furthermore, as my column pointed out, Keynes’s investing performance improved when he stopped relying on his own macroeconomic forecasts.
You may also wish that Keynes was somehow front-running his own policies, but that doesn’t make it true, either. His play on gold-mining shares was motivated by the devaluation of the South African rand, which had nothing to do with his own policies. And his strategic shift into mining stocks played out over the course of six or seven years, hardly the sort of timescale over which anyone would try a front-running scheme.
It’s also worth reemphasizing that the Keynes portfolio analyzed in the new research wasn’t his personal fortune; it was the endowment fund of King’s College at the University of Cambridge. To suggest that Keynes was effectively lining his own pockets with the misfortunes that his bad policies inflicted on other people doesn’t wash.
In short, what you think about Keynes as an economic theorist should have nothing to do with the question of how good an investor he was.
Similarly, investors should always be on guard against the halo effect and confirmation bias. When you ask a question about an investment, make sure you don’t end up answering a different question entirely.