The Devil’s Dictionary

Investing
Behavioral Finance
By
Sarah F. Roach

Financial professionals—collectively known as “Wall Street”—often use jargon that confuses investors and presses their emotional buttons. While Wall Street products may claim to benefit investors’ financial welfare, the salesman’s welfare may be the true beneficiary. Wall Street Journal columnist Jason Zweig’s recent book, The Devil’s Financial Dictionary, tries to unravel Wall Street double talk. Although it’s written largely tongue-in-cheek, the book gets at the importance of understanding successful investing as well as having trust in the firm that invests your nest egg.

Zweig patterned his book after satirist Ambrose Bierce’s 1906 book, The Devil’s Dictionary—an attack on “euphemism, hypocrisy and muddleheaded thinking.” In the introduction, Zweig explains that he doesn’t consider most on Wall Street to be evil—rather complacent and overconfident (though the impact can be the same). “… Like most human beings, people in the financial industry are better at rationalizing than at being rational.” The book is laid out in dictionary fashion, though his definitions are often more interpretive than strictly factual. Many are terms we’ve strived to re-define— really, accurately define—in our letters over the years.

One example is the definition of “risk.” Wall Street often defines risk as short-term volatility—an error we’ve repeatedly corrected. Zweig writes that risk is formally defined as “the odds of an adverse outcome,” but he actually begins his definition as “the chance that you don’t know what you are doing when you think you do; the prerequisite for losing more money in a shorter period of time than you could ever have imagined possible.” To our minds, this is exactly what happens when normal, short-term price volatility scares investors into emotional selling. In July 2011 we wrote, “…suppose you become rattled by a drop in stock prices and decide to sell ‘until things clear up.’ Unless you decide to reinvest when stock prices are lower (and the outlook scarier) than when you sold—an extremely unlikely event—then your lost oppor­tunities are likely to be permanent.”

Taking this concept a step further, Zweig defines “downside risk” as “…the chance of losing money; the only kind of RISK there is, as no one seeks to avoid ‘upside risk,’ or making money. Unfortunately, many … who seek to minimize downside risk … seem to end up elimi­nating any possible upside risk instead.” We’ve observed that investors seem to worry only when price declines grab the headlines (and their attention)—never during price jumps. Yet both forms of volatility are inevitable and can represent short-term deviations from economic reality that intelligent investors should take advantage of rather than fear.

Switching gears, Zweig’s definition of behavioral economics sums up why we cite it so often: “[It’s] the study of how human beings make decisions about money—as opposed to traditional … economics, which studies how economists think human beings would make decisions about money if all human beings thought the way economists think they do.” While we might not agree with all of Zweig’s definitions, his illuminating mini-stories are often amusing, and the book captures many of our thoughts about Wall Street mumbo jumbo.