RISK FINANCIAL MARKETS & YOU

Financial industry veteran Fustey explains how a naïve view of risk and faulty decision-making leads investors down the road to disappointment.

If common sense says to “buy low, sell high,” then why are so many individual investors stymied by investments that fail to live up to their expectations? Fustey argues that much of the problem lies in the investor’s brain. Pointing to research from the fields of neuroeconomics and behavioral economics, the author describes the battle between our “two minds,” where our evolved “logical brain” and our more primal “automatic brain” compete for dominance while making decisions. The conundrum is made worse by the fact that humans do not always process information correctly. The book adeptly catalogs the biases and mental shortcuts that can distort our perception of risk. Trading based on news reports and a tendency to follow the herd are just two mindsets that can negatively impact investment decision-making. Fustey also lambastes two prevailing investment theories—the Efficient Market Theory and the Modern Portfolio Theory—as flawed. His criticism extends to the financial-advice industry and actively managed investments such as mutual funds, which he contends are riddled with hidden costs, conflicts of interest and self-serving tactics that exploit investor weaknesses. Perhaps the book’s biggest warning is to avoid “chasing past returns”; too many investors mistakenly believe an investment’s past returns can predict its future performance. A novice may be intimidated by the complex financial concepts covered in the book, but the author manages to express his views in everyday language bolstered with supporting evidence. Fustey ultimately proposes a practical, though not effortless, solution—combining exchange-traded funds with the strategic use of puts and calls to hedge against damaging losses. As with everything in the investing world, the book’s arguments likely will be disputed by other financial experts. At the very least, however, it can prompt the average investor to ask tougher questions when his financial advisor pitches another mutual fund that seems like a sure bet. Persuasive, no-holds-barred advice that will lead investors to rethink where they put their nest eggs.