Finding the Sources and Methods of Financial Expertise in a Haystack

What evidence is there that economically significant financial expertise exists? How can research best discover where such expertise comes from and how it works? In the September 2005 draft of their paper entitled “The Enigma of Financial Expertise: Superior and Reproducible Investment Performance in Efficient Markets”, Anders Ericsson, Patric Andersson and Edward Cokely tackle these questions. Based on review of prior research in the context of a broad perspective on expertise across many fields, they conclude that:

• On average, expert investors outperform stock indexes and random selection methods by a small margin before transaction costs, but this outperformance does not exceed transaction costs. Non-expert investors tend to underperform random selection methods. The behavior of financial experts makes markets efficient.
• Consistent with research on expertise in other fields, industry specialization and in-depth (insider) company knowledge relates positively to reproducible investing outperformance. More precisely, superior investors wait for opportunities among a small set of companies about which they have in-depth knowledge. Finding extraordinarily profitable stocks is likely a function of the number of chances taken rather than skill.
• Financial expertise probably comes from extensive deliberate practice that supports accumulation of specialized knowledge, expands reasoning abilities and limits biases.
• Unraveling the sources and methods of financial expertise requires systematic investigation of realistic investing tasks (not abstract laboratory scenarios).
• Compared to expert-amateur differentiation in sports and games, the average advantage of financial experts over non-experts in investing and forecasting seems very small. The very small margin of outperformance makes empirical study of financial expertise difficult, and even brings into question whether such study is worthwhile.

The paper offers many citations of prior research on the existence, nature and economic value of investing expertise.

In summary, the difference between expert and non-expert performance in investing and financial forecasting is small, making it difficult to discover the nature of financial expertise. Tests of expertise must be realistic.

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