Here is a summary of what you will learn in Behavioural Finance:
Conventional finance is based on the theories which describe people for the most part behave logically and rationally. People started to question this point of view as there have been anomalies, which are events that conventional finance has a difficult time in explaining.
Three of the biggest contributors to the field are psychologists, Drs. Daniel Kahneman and Amos Tversky, and economist, Richard Thaler.
The concept of anchoring draws upon the tendency for us to attach or "anchor" our thoughts around a reference point despite the fact that it may not have any logical relevance to the decision at hand.
Mental accounting refers to the tendency for people to divide their money into separate accounts based on criteria like the source and intent for the money. Furthermore, the importance of the funds in each account also varies depending upon the money's source and intent.
Seeing is not necessarily believing as we also have confirmation and hindsight biases. Confirmation bias refers to how people tend to be more attentive towards new information that confirms their own preconceived options about a subject. The hindsight bias represents how people believe that after the fact, the occurrence of an event was completely obvious.
The gambler's fallacy refers to an incorrect interpretation of statistics where someone believes that the occurrence of a random independent event would somehow cause another random independent event less likely to happen.
Herd behavior represents the preference for individuals to mimic the behaviors or actions of a larger sized group.
Overconfidence represents the tendency for an investor to overestimate his or her ability in performing some action/task.
Overreaction occurs when one reacts to a piece of news in a way that is greater than actual impact of the news.
Prospect theory refers to an idea created by Drs. Kahneman and Tversky that essentially determined that people do not encode equal levels of joy and pain to the same effect. The average individuals tend to be more loss sensitive (in the sense that a he/she will feel more pain in receiving a loss compared to the amount of joy felt from receiving an equal amount of gain).
Read more: Behavioral Finance: Conclusion | Investopedia http://www.investopedia.com/university/behavioral_finance/behavioral12.asp#ixzz3qP6bHYmC
Keep INVESTING Simple and Safe (KISS) ****Investment Philosophy, Strategy and various Valuation Methods**** The same forces that bring risk into investing in the stock market also make possible the large gains many investors enjoy. It’s true that the fluctuations in the market make for losses as well as gains but if you have a proven strategy and stick with it over the long term you will be a winner!****Warren Buffett: Rule No. 1 - Never lose money. Rule No. 2 - Never forget Rule No. 1.
Showing posts with label BEHAVIOURAL FINANCE. Show all posts
Showing posts with label BEHAVIOURAL FINANCE. Show all posts
Tuesday 3 November 2015
Friday 26 June 2015
"The 4 Diseases" of Investing - Evenitis (holding to losers), Taking profits (selling winners), Over-trading and FOMO
Teaminvest Co-founder Professor John Price, recently recorded an informative 4.5 minute video about the behavioural biases that often block rational decision-making about investments.
It’s titled “The 4 Diseases”. In the video he explains the four common behavioural biases and fuzzy thinking affecting the way we assess investments. He calls them:
Click on John's pic
It’s titled “The 4 Diseases”. In the video he explains the four common behavioural biases and fuzzy thinking affecting the way we assess investments. He calls them:
- Get even-itus
- Consolidatus-profitus
- Trade-a-filia
- FOMO
Click on John's pic
Regards
NOTES: Stock selection - Read the annual reports - Read all the analysts reports - Visit the stores or use their products and services If you find that at the end of the day, the performance of the portfolio is not that good, or mediocre at best, in many cases there are various reasons. They often have not taken into account behavioural biases, the sort of fuzzy thinking that is automatically in their mind that blocks out their rational decision. These are the 4 behavioural biases, which we refer to them as: |
- Get even-itus
- Consolidatus-profitus
- Trade-a-filia
- FOMO
The disease of hanging onto a stock when the price has gone down until you can get even. "Don't worry dear, it is going to come up back again." The problem is, if the stock has gone down, the chances are it is going to continue to go down and best it is going to be a mediocre investment. It is much better to face the fact that you have a loser, you lost money and to move on.
Consolidatus-profitus
This is the opposite to get even-itus. This is the disease of always taking a profit when the price goes up. It looks great and you can tell your friend at the dinner party that your stock went up 20%, 40% or 50% and you sold it. The problem is what you are going to do with that money. Studies have shown, on average, people who sell just to take a profit end up putting their money back into the market in a stock that underperforms the one they got out of. #
Get even-itus and Consolidatus-profitus are two sides of the one coin; generally hang on to losers and sell winners. The opposite would be better, that is, sell your losers and hold on to your winners. They water the weeds and cut the flowers. It would be better they water the flowers and cut the weeds.
Trade-a-filia
This is the disease of just loving to trade. Most people who would never dream of going to casino betting on roulette or any of the casino games or machines,yet when they are on their internet and looking at their stocks, they trade far too often. It is so simple to trade on the internet and they get drawn into it. But studies have shown that on average, the more a person trades they worse they do. I am not referring to their transaction costs but actually their performance diminishes. Instead of looking for great companies that are going to make you money year after year, they think they can get a short term profit. In the short term, the share prices are much more random than most people believe. So this is a disease of trading too often. In this regard, women are better investors than men, because overall, women trade less than men.
FOMO
This is the 4th disease, the FEAR OF MISSING OUT. You read about a particular stock and its price is going up and you think, if I don't get in now, I am going to miss out, instead of taking your time and evaluating the stock properly.
These 4 diseases really work together and at best give you a mediocre performance that is far far below you optimal performance.
You should work to eliminate these 4 investing biases or diseases, consciously. Use tight filters to filter out the best companies to concentrate in.
Be alert that you are not slipping into these investment biases. Eliminate these investing biases and your performance will be much better.
# Reinvestment risk.
Sunday 17 November 2013
'Being human" costs the average investor around 3 - 4% in return every year.
The cost of being human
When it comes to investing, human nature doesn’t help. Our innate need for emotional comfort is estimated to cost the average investor around 3–4% in returns every year.* And for many, the figure can be much greater.This shortfall in returns is partly caused by what is known as the Behaviour Gap. It explains the difference between long-term financial returns (if we were only to stick to sensible and simple rules for investing) and actual returns (which are determined by all our short-term decision-making, often based on our emotional needs).
A good example is how our investment strategy often goes off course in turbulent times. So despite the obvious costs, we can often end up buying high and selling low.
*Source: Barclays Wealth & Investment Management, White Paper - March 2013, ‘Overcoming the Cost of Being Human’.
http://www.investmentphilosophy.com/fpa/
Saturday 16 November 2013
Recency Bias or the Party Effect
Overview
The Party Effect or Recency Bias is where stock market participants evaluate their portfolio performance based on recent results or on their perspective of recent results and make incorrect conclusions that ultimately lead to incorrect decisions about how the stock market behaves. This is a very important concept to understand. Let’s set the stage for an illustration of how this happens.
Examples
A Party Tale
“You’re Right”
One of my favorite life lessons centers around President Franklin Delano Roosevelt, also known as FDR. FDR had many strengths but I think his greatest was his ability to recognize that things are not always black and white. I think his ability to see the big picture as well as discern the subtleties of a situation is what made him such an effective leader and brought out the best in others.
In one well known FDR story, he asks one of his trusted advisors what he thinks about a particular situation and after he listens to the advisor, FDR replies “You’re Right.” Not long after FDR asks another of his trusted advisors for his opinion on the same matter and this advisor gives the exact opposite recommendation from the first advisor to which FDR once again replies “You’re Right.”
At hearing FDR’s reply to the second advisor one of FDR’s closest advisors that had listened to FDR’s response to both advisors, points out the obvious contradiction to which FDR replies “You’re Also Right.”
Much can be learned from what at first appears to be FDR’s flippant and contradictory remarks to his advisors. However, FDR was far wiser. FDR understood that all three advisors were in fact right. They were just right from their perspective. But they didn’t have a view of the big picture. The contrast between FDR’s perspective of the entire situation compared to the trusted advisor’s perspective of a narrow part of the situation is what creates the dichotomy. The stock market works much the same way.
A different example would be the poem about the six blind men and the elephant. Each of the six blind men is asked to describe an elephant. Their perceptions lead to misinterpretation because they each describe the elephant differently depending on which part of the elephant they touch. One touches the side and describes the elephant like a wall. The other the tusk and describes the elephant as a spear. The next touches the trunk and describes a snake. The next the knee and describes a tree. The next an ear and describes a fan. Finally the last touches the tail and describes the elephant like a rope.
This tale is about the stock market and how investors relate to the stock market. The stock market can be viewed as FDR or the elephant while investors or participants in the stock market can be viewed as the advisors or the blind men. When describing the stock market each participant sees their portfolio’s performance from their perspective only and thus they are always “right” which leads to what I call The Party Effect or what Financial Behaviorist call the Recency Bias.
Imagine that you attended a party hosted by your investment advisor and that in addition to you, also in attendance were several other clients. As you go around the room and meet people you learn that everyone at the party owns the exact same S&P 500 index mutual fund. I use the S&P 500 for this tale because by many measures it has historically produce an average rate of return of about 12% and as many people know, and now you know as well, it represents what many investors call “the stock market.” The question then is would everyone have the same rate of return at this party? Of course the answer is, no they would not. If they started at the same time they would but since people invest or come into the life of the investment advisor at different times, the answer is no.
Let’s tighten up the party attendee list and invite only 30 guests. For simplicity, let’s assume that Guest 1 purchased the fund 30 months ago, that Guest 2 purchased it 29 months ago, that Guest 3 purchased it 28 months ago, etc. What would the guests discuss? What would be their perspectives of the stock market?
In order to determine what the guests would discuss and how they would evaluate their performance we need to have some data in the form of monthly rates of return. So we need to develop a monthly rate of return for 30 months to see what they see. Again, for simplicity, assume that for the first 18 months the fund goes up 3% per month and for the next 12 months it goes down 2% per month. Please note that I didn’t pick this sequence of numbers randomly. I have a purpose to this. This particular sequence approximates how the stock market moves in terms of bull and bear market duration and after 30 months returns approximately 12%; 12.28% to be exact. This sequence of numbers is a good sequence to illustrate The Party Effect or Recency Bias. We can characterize the first 18 months as the bull market phase of the 30-month cycle and the last 12 months as the bear market phase of the 30-month cycle.
To illustrate The Party Effect lets focus on 4 guests and see how they describe the stock market. Remember the FDR and elephant example from the start of this tale. Let’s look at guests 1, 10, 19 and 25. I picked these 4 because readers of this tale can relate in some form or another to one of these 4.
- Guest 1 started 30 months ago, at the beginning of the bull market phase, and his rate of return is 12.28% for the entire 30-month cycle. He enjoyed the ride up for 18 months and now the ride down for the last 12.
- Guest 10 started 21 months ago, halfway through the bull market phase, and his rate of return is 1.36% for the 21-month period he has been invested.
- Guest 19 started 12 months ago, at the beginning of the bear market phase, and his rate of return is -21.53% for the 12-month period he has been invested.
- Finally, Guest 25 started 6 months ago, halfway through the bear market phase, and his rate of return is
–11.42 for the 6-month period he has been invested.
These 4 guests experienced entirely different rate of return outcomes and view their portfolios and thus the stock market completely different. All 4 are correct. All 4 are right and yet they couldn’t possibly have more divergent outcomes. If they don’t have a complete picture of the stock market, like the elephant, they can get themselves in trouble. The difference between the best performing portfolio that is up 12.28% and the worst performing portfolio that is down 21.53% is an astounding 33.81%. Is this too obvious? You may say, of course they have different outcomes, they started at different times but that is not the point. The point is that stock market investing will always produce different outcomes. One guest started at the worst time possible. Another guest started at the best possible time. How they look at the past determines how they see the present. Most importantly, it will determine how they will act going forward.
The Party Effect simply states that stock market participants evaluate their portfolio performance based on their perspective and their perspective only. They do not see the market as it is but as they are. Without an expert understanding of how the stock market works, this leads to incorrect conclusions that ultimately lead to incorrect decisions. The field of Behavioral Finance (BF) has shown time and time again that people have variable risk profiles. BF demonstrates that fear is a stronger emotion than greed. This means that in our simple 4 guest example, Guests 3 and 4 are more likely to exit the stock market at just the wrong time since their recent, thus Recency Bias, experience is one of losing money. It means that Guest 1 and 2 are more likely to stay invested, thus catching the next wave up that is likely to follow. All 4 have intellectual access to the events of the last 30 months. All 4 can educate themselves on the stock market. However, their particular situation is so biased by recent events that the facts are unimportant. They behave irrationally. I have witnessed this irrational behavior throughout my career. No one is immune, even advisors.
There are ways to combat The Party Effect trap but it is the deadliest of all the stock market traps that I know. Few can overcome it. The only sure way to overcome it is to become an expert on the stock market yourself, learn to manage your emotions, and then either manage your own money or hire competent managers that you recognize are expert in their chosen investment discipline. However, if you hire an expert on the stock market you have not solved the problem if you do not have expertise. Let me repeat this sentence and highlight it. If you hire an expert on the stock market you have not solved The Party Effect trap if you do not have expertise yourself. When you hire an expert on the stock market without being an expert yourself all you have done is added complexity to a complex problem. You have inserted another variable between you and the stock market. You now have three variables to worry about, the stock market, your advisor and yourself. Without expertise you have no way of knowing if your advisor is an expert. You are in an endless loop. You are in a recursive situation. Just like we ask, what came first the chicken or the egg? The Party Effect asks, how do I hire an expert without being an expert myself?
If you are unwilling to become an expert on the stock market you must find a way to solve The Party Effect trap? How do you do it? As a first step I suggest you read An Expert Tale to make sure the person you hire is in fact an expert and then hire them. The original intent of my Financial Tales project was to educate my kids and others I love. With that as a backdrop, this means I highly recommend you avoid dealing with any advisor that does not have a fiduciary relationship with you the client. Why, because you are adding a 4th variable to an already complex situation. You are adding the ever present conflict of interest that every non-fiduciary advisor has with their client. This 4th variable makes a successful outcome all but impossible. I recognize that these words are harsh but I believe your odds of success drop dramatically once you introduce the non-fiduciary variable. I don’t know what the future holds, but today you must avoid conflicted advisors at firms such as Merrill Lynch, Smith Barney, Morgan Stanley, etc. I expect that the non-fiduciary model of providing people with investment advice based on the size of the advertising budget will go the way of the dinosaur, but for as long as it exists, you must avoid this ilk of advisors.
What is the second step to avoiding The Party Effect trap? There is no second step. You either develop investment expertise or you learn to recognize experts and hire them. You can’t avoid or abdicate this charge. You must embrace your responsibility or you will suffer or those you love will suffer. It behooves the reader to invest their time in what is one of the most important decisions they will ever make and must make every day.
http://www.wikinvest.com/wiki/Recency_bias
The Party Effect or Recency Bias is where stock market participants evaluate their portfolio performance based on recent results or on their perspective of recent results and make incorrect conclusions that ultimately lead to incorrect decisions about how the stock market behaves. This is a very important concept to understand. Let’s set the stage for an illustration of how this happens.
Examples
A Party Tale
“You’re Right”
One of my favorite life lessons centers around President Franklin Delano Roosevelt, also known as FDR. FDR had many strengths but I think his greatest was his ability to recognize that things are not always black and white. I think his ability to see the big picture as well as discern the subtleties of a situation is what made him such an effective leader and brought out the best in others.
In one well known FDR story, he asks one of his trusted advisors what he thinks about a particular situation and after he listens to the advisor, FDR replies “You’re Right.” Not long after FDR asks another of his trusted advisors for his opinion on the same matter and this advisor gives the exact opposite recommendation from the first advisor to which FDR once again replies “You’re Right.”
At hearing FDR’s reply to the second advisor one of FDR’s closest advisors that had listened to FDR’s response to both advisors, points out the obvious contradiction to which FDR replies “You’re Also Right.”
Much can be learned from what at first appears to be FDR’s flippant and contradictory remarks to his advisors. However, FDR was far wiser. FDR understood that all three advisors were in fact right. They were just right from their perspective. But they didn’t have a view of the big picture. The contrast between FDR’s perspective of the entire situation compared to the trusted advisor’s perspective of a narrow part of the situation is what creates the dichotomy. The stock market works much the same way.
A different example would be the poem about the six blind men and the elephant. Each of the six blind men is asked to describe an elephant. Their perceptions lead to misinterpretation because they each describe the elephant differently depending on which part of the elephant they touch. One touches the side and describes the elephant like a wall. The other the tusk and describes the elephant as a spear. The next touches the trunk and describes a snake. The next the knee and describes a tree. The next an ear and describes a fan. Finally the last touches the tail and describes the elephant like a rope.
This tale is about the stock market and how investors relate to the stock market. The stock market can be viewed as FDR or the elephant while investors or participants in the stock market can be viewed as the advisors or the blind men. When describing the stock market each participant sees their portfolio’s performance from their perspective only and thus they are always “right” which leads to what I call The Party Effect or what Financial Behaviorist call the Recency Bias.
Imagine that you attended a party hosted by your investment advisor and that in addition to you, also in attendance were several other clients. As you go around the room and meet people you learn that everyone at the party owns the exact same S&P 500 index mutual fund. I use the S&P 500 for this tale because by many measures it has historically produce an average rate of return of about 12% and as many people know, and now you know as well, it represents what many investors call “the stock market.” The question then is would everyone have the same rate of return at this party? Of course the answer is, no they would not. If they started at the same time they would but since people invest or come into the life of the investment advisor at different times, the answer is no.
Let’s tighten up the party attendee list and invite only 30 guests. For simplicity, let’s assume that Guest 1 purchased the fund 30 months ago, that Guest 2 purchased it 29 months ago, that Guest 3 purchased it 28 months ago, etc. What would the guests discuss? What would be their perspectives of the stock market?
In order to determine what the guests would discuss and how they would evaluate their performance we need to have some data in the form of monthly rates of return. So we need to develop a monthly rate of return for 30 months to see what they see. Again, for simplicity, assume that for the first 18 months the fund goes up 3% per month and for the next 12 months it goes down 2% per month. Please note that I didn’t pick this sequence of numbers randomly. I have a purpose to this. This particular sequence approximates how the stock market moves in terms of bull and bear market duration and after 30 months returns approximately 12%; 12.28% to be exact. This sequence of numbers is a good sequence to illustrate The Party Effect or Recency Bias. We can characterize the first 18 months as the bull market phase of the 30-month cycle and the last 12 months as the bear market phase of the 30-month cycle.
To illustrate The Party Effect lets focus on 4 guests and see how they describe the stock market. Remember the FDR and elephant example from the start of this tale. Let’s look at guests 1, 10, 19 and 25. I picked these 4 because readers of this tale can relate in some form or another to one of these 4.
- Guest 1 started 30 months ago, at the beginning of the bull market phase, and his rate of return is 12.28% for the entire 30-month cycle. He enjoyed the ride up for 18 months and now the ride down for the last 12.
- Guest 10 started 21 months ago, halfway through the bull market phase, and his rate of return is 1.36% for the 21-month period he has been invested.
- Guest 19 started 12 months ago, at the beginning of the bear market phase, and his rate of return is -21.53% for the 12-month period he has been invested.
- Finally, Guest 25 started 6 months ago, halfway through the bear market phase, and his rate of return is
–11.42 for the 6-month period he has been invested.
These 4 guests experienced entirely different rate of return outcomes and view their portfolios and thus the stock market completely different. All 4 are correct. All 4 are right and yet they couldn’t possibly have more divergent outcomes. If they don’t have a complete picture of the stock market, like the elephant, they can get themselves in trouble. The difference between the best performing portfolio that is up 12.28% and the worst performing portfolio that is down 21.53% is an astounding 33.81%. Is this too obvious? You may say, of course they have different outcomes, they started at different times but that is not the point. The point is that stock market investing will always produce different outcomes. One guest started at the worst time possible. Another guest started at the best possible time. How they look at the past determines how they see the present. Most importantly, it will determine how they will act going forward.
The Party Effect simply states that stock market participants evaluate their portfolio performance based on their perspective and their perspective only. They do not see the market as it is but as they are. Without an expert understanding of how the stock market works, this leads to incorrect conclusions that ultimately lead to incorrect decisions. The field of Behavioral Finance (BF) has shown time and time again that people have variable risk profiles. BF demonstrates that fear is a stronger emotion than greed. This means that in our simple 4 guest example, Guests 3 and 4 are more likely to exit the stock market at just the wrong time since their recent, thus Recency Bias, experience is one of losing money. It means that Guest 1 and 2 are more likely to stay invested, thus catching the next wave up that is likely to follow. All 4 have intellectual access to the events of the last 30 months. All 4 can educate themselves on the stock market. However, their particular situation is so biased by recent events that the facts are unimportant. They behave irrationally. I have witnessed this irrational behavior throughout my career. No one is immune, even advisors.
There are ways to combat The Party Effect trap but it is the deadliest of all the stock market traps that I know. Few can overcome it. The only sure way to overcome it is to become an expert on the stock market yourself, learn to manage your emotions, and then either manage your own money or hire competent managers that you recognize are expert in their chosen investment discipline. However, if you hire an expert on the stock market you have not solved the problem if you do not have expertise. Let me repeat this sentence and highlight it. If you hire an expert on the stock market you have not solved The Party Effect trap if you do not have expertise yourself. When you hire an expert on the stock market without being an expert yourself all you have done is added complexity to a complex problem. You have inserted another variable between you and the stock market. You now have three variables to worry about, the stock market, your advisor and yourself. Without expertise you have no way of knowing if your advisor is an expert. You are in an endless loop. You are in a recursive situation. Just like we ask, what came first the chicken or the egg? The Party Effect asks, how do I hire an expert without being an expert myself?
If you are unwilling to become an expert on the stock market you must find a way to solve The Party Effect trap? How do you do it? As a first step I suggest you read An Expert Tale to make sure the person you hire is in fact an expert and then hire them. The original intent of my Financial Tales project was to educate my kids and others I love. With that as a backdrop, this means I highly recommend you avoid dealing with any advisor that does not have a fiduciary relationship with you the client. Why, because you are adding a 4th variable to an already complex situation. You are adding the ever present conflict of interest that every non-fiduciary advisor has with their client. This 4th variable makes a successful outcome all but impossible. I recognize that these words are harsh but I believe your odds of success drop dramatically once you introduce the non-fiduciary variable. I don’t know what the future holds, but today you must avoid conflicted advisors at firms such as Merrill Lynch, Smith Barney, Morgan Stanley, etc. I expect that the non-fiduciary model of providing people with investment advice based on the size of the advertising budget will go the way of the dinosaur, but for as long as it exists, you must avoid this ilk of advisors.
What is the second step to avoiding The Party Effect trap? There is no second step. You either develop investment expertise or you learn to recognize experts and hire them. You can’t avoid or abdicate this charge. You must embrace your responsibility or you will suffer or those you love will suffer. It behooves the reader to invest their time in what is one of the most important decisions they will ever make and must make every day.
http://www.wikinvest.com/wiki/Recency_bias
The investment mistakes caused by framing
Behavioural finance: The investment mistakes caused by framing
In this post on behavioural investing, we'll look at the dramatic effects the concept of framing can have in an investment context.
Peoples' personality traits can hugely affect the way they react to the actual performance of their portfolio in the future. For example, consider a situation where two investors (Bob and Brian) have made the same investment. Over one year, the market average rises 10 per cent but the individual investment value increases by 6 per cent.
Bob cares only about the investment return and frames this as a gain of 6 per cent. Brian is concerned with how the investment performs relative to the benchmark of the market average. The investment has lagged behind the market’s performance and Brian frames this as a loss of 4 per cent. Which investor is likely to be happier with the performance of their investment?
Because of the way that individuals feel losses more than gains, Bob is much more likely to be happy with the investment than Brian. Their differing reactions here will frame their future investment decisions. Another problem for investors is the strong tendency for individuals to frame their investments too narrowly – looking at performance over short time periods, even when their investment horizon is long term. People also struggle to consider their portfolio as a whole, focusing too narrowly on the performance of individual components.
Because of the way that individuals feel losses more than gains, Bob is much more likely to be happy with the investment than Brian. Their differing reactions here will frame their future investment decisions. Another problem for investors is the strong tendency for individuals to frame their investments too narrowly – looking at performance over short time periods, even when their investment horizon is long term. People also struggle to consider their portfolio as a whole, focusing too narrowly on the performance of individual components.
The 70% rule
Consider the “70% rule” that advises people to plan on spending about 70 per cent of their current income during their retirement.
For most people, this rule of thumb is intuitively appealing, which could explain why it has become so popular among financial planners. Now let’s use slightly different lenses and reframe the 70 per cent rule as the 30 per cent rule. That is, rather than focusing on the 70 per cent of expenditures someone would sustain through retirement, let’s consider the 30 per cent of expenditures that should be eliminated. Most people find the 30 percent rule unpalatable, even though the 70 per cent and 30 per cent rules are mathematically identical.
Investors hate losses
Individuals are extremely sensitive to the way in which decisions are presented or ‘framed’ – simply changing the wording or adding irrelevant background detail can dramatically change peoples' perceptions of the alternatives available to them, even where there is no reason for their underlying preferences to have changed. When individuals make investment decisions, emotion and reason work together, but they produce very different emotional results depending on whether the investment made or lost money. For example, according to Shefrin, people tend to feel losses much more strongly than the pleasure of making a comparable gain.
This emotional strain is magnified when the person assumes responsibility for the loss. This guilt feeling then produces an aversion to risk. But this level of guilt can be changed depending on how a financial decision is framed. For example, if an adventurous investor seeking attractive returns over the long-term made close to 100 per cent over two years and then lost 20 per cent in year three, the investor could justify the year three loss by saying that even though they suffered a hefty loss over a twelve month period, the fact remains that they had made an annual return over the three years of 21.6 per cent which would be classed by many as impressive performance.
Myopic thinking can lead to investment mistakes
Behavioral finance's answer to the equity premium puzzle revolves around the tendency for people to have "myopic loss aversion", a situation in which investors - overly preoccupied by the negative effects of losses in comparison to an equivalent amount of gains – take a very short-term view on an investment. What happens is that investors are paying too much attention to the short-term volatility of their portfolios.
While it's not uncommon for an average stock or fund to fluctuate a few percentage points in a very short period of time, a myopic (i.e. shortsighted) investor may not react too favourably to the downside changes. Therefore, it is believed that equities must yield a high-enough premium to compensate for the investor's considerable aversion to loss.
Over-monitoring performance
How frequently you monitor your portfolio’s performance can bias your perception of it. Suppose you were investing over a 5-year investment horizon in a high-risk equity portfolio. The table below presents how you would perceive the portfolio depending on the monitoring period. Over the appropriate 5-year time frame, equity performance has been positive 90 per cent of the time, and so risky investments do not lose money more than 10 per cent of the time. However, if you were to monitor the performance of the same portfolio on a month-by-month basis, you would observe a loss 38 per cent of the time!*
Once again, because of our inherent aversion to loss, monitoring your portfolio more frequently will cause you to observe more periods of loss, making it likely you'll feel more emotional stress and take on less risk than is appropriate for your long-term investment objectives.
Observing short-term fluctuations in the value of an investment is likely to cause more discomfort for investors who are particularly sensitive to losses. This may prevent them from investing in such a portfolio and thus lose out on the higher potential returns that they would get by taking on appropriate levels of risk.
* Source: Kahneman and Riepe, 1998.
http://web.isaco.co.uk/blog/bid/147855/Behavioural-finance-The-investment-mistakes-caused-by-framing
Friday 15 November 2013
Availability Bias
AVAILABILITY BIAS
The next cognitive illusion is known as availability bias. When confronted with a decision, humans’ thinking is influenced by what is personally relevant, salient, recent or dramatic. Put another way, humans estimate the probability of an outcome based on how easy that outcome is to imagine.
Consider the following example. In the months after the September 11 terrorist attacks, travelers made the decision that travelling to their destination by car was a far safer way than by air. In light of the very recent (at the time), salient and dramatic events of September 11, this decision seemed an obvious and wise one. The probability of danger when travelling by air seemed much greater than travelling by car… when you think about it, at that time, it was far easier to imagine something bad happening when travelling by air.
However, this was the availability heuristic at work. The truth of the matter was that firstly, air travel had never been safer than in the months following September 11, on account of the massively increased security. And secondly, on account of far more people hitting the roads come holiday time, there were inevitably many more fatal accidents. Upon examination of the statistics, it was far more dangerous to drive than to fly (US road fatalities in October-December 2001 were well above average) and yet, the availability bias humans suffer from made many feel that driving was the smarter choice… this decision-making error cost some people their lives.
We also apply this bias in the world of investing. For instance, availability bias can result in our paying more attention to stocks covered heavily by the media, while the availability of information on a stock influences our tendency to invest in a stock. The dot.com boom of 1999/2000 is a great example. The availability of information and media coverage of internet stocks was such that people were more inclined to invest in them than they would have otherwise been.
Be wary of following the latest market fad simply because of the availability of information. If you have read it in the newspaper, you may well be amongst the last in the market to know!!
http://stockmarketinvesting.com.au/Availability-Bias.html
Thursday 26 September 2013
Golden rules for losing money. To make money, sometimes it's better to first concentrate on not losing it.
This article explains the classic investment mistakes that, to be successful, you should avoid at all costs.
To make money, sometimes it's better to first concentrate on not losing it.
Investing successfully poses many challenges. Here are some of the techniques that can help you to rise to these challenges but first, one of our favourite tools, from mathematician Carl Jacobi.
He was fond of saying, 'invert, always invert' and that's what we're going to do here. Instead of looking at how to make money, we're going to look at great ways to lose it. That way you can aim to minimise your mistakes-a vital part of investing successfully.
So here they are, classic investment mistakes guaranteed to ensure woeful performance.
1. Trade fast and trade often
Charlie Munger, Warren Buffett's business partner, often refers to the huge mathematical advantages of 'doing nothing' to your portfolio. Let's blindly ignore the very large tax benefits of holding stocks for the long term and just consider the impact of brokerage.
Someone who 'turns over' (buys and sells) all the stocks in their portfolio several times a year is at least a few percent behind the eight ball, even with internet brokerage rates as low as 0.3%. Add up the brokerage from your last tax return to see what we mean.
There's also an important, but less measurable, benefit to taking a longer-term approach. It makes you think long and hard about which stocks to include in your portfolio. When you are considering buying a stock for 10 years or more, you tend to pick quality businesses. And that can only be a good thing.
So, if your intention is to lose money (and enrich your broker), trade fast and frequently.
2. Follow the mainstream media
Hopefully, you are somewhat against this particular human folly. Most people, though, aren't so resistant.
Munger refers to a human condition known as 'incentive-caused bias' and it explains the functioning of media quite nicely. There's a widely held belief, and it may be correct, although declining newspaper circulations suggest otherwise, that emotional, confrontational, dramatic coverage sells more papers than rational, factual reporting. Hence the tendency to induce panic in investors when calmness would better serve their interests.
But incentive-caused bias doesn't just affect the media. Just look at how honest managing directors can first convince themselves, then their board, then their shareholders, how an offshore acquisition or hostile takeover will be great for everyone, especially themselves. Generous options packages offer a fitting explanation for many examples of corporate foolishness.
To lose money, avert your eyes from a factual assessment of a situation and bury yourself in the opinions and arguments of those with a vested interest in convincing you of the veracity of their own opinion.
3. Follow fads or 'hot stocks'
In his highly recommended book Influence: The Psychology of Persuasion , Robert Cialdini talks about another human condition known as 'social proof'. The evolution of the human species, and sheep, was greatly assisted by a tendency to follow the crowd-safety in numbers and all that.
Anyone who thinks that social proof is solely the preserve of the historian should study the mania of the dot com boom. Millions, gulled with the fear of standing apart from the crowd, played a huge role in firing the mania. Conformity still dictates many areas of life but following the stockmarket crowd can be a costly mistake. As Buffett says, 'you pay a very high price in the stockmarket for a cheery consensus.'
That's why we are most often excited when others are depressed and fearful when others are optimistic (see our review of FKP on page 6). And it explains why we're worried about China, nickel stocks and other areas like the spate of listed investment company floats that are currently running hot.
If you're intent on seeing your net worth dwindle, follow hot stocks and sectors.
4. Beat yourself up over lost opportunities
'Right decision, wrong result'. In an imperfect activity like investing, mistakes are absolutely inevitable. But, odd as it may sound, sometimes even when you're right, you're wrong.
To call tech stocks overvalued in mid-1999 was undoubtedly correct. But for the next six months, as speculators pushed prices higher still, it sure didn't feel correct. It's a fact of life that someone will always be getting rich a little quicker than you are. But then again, they may become poor just as quickly by adopting the same approach.
If you take the conservative decision not to invest in a stock, and it goes up anyway, don't fret. Just be patient-other opportunities are often just around the corner. But if you are interested in blowing your capital, now's a good time to capitulate and buy at these higher prices.
5. Buy cyclical stocks at the top
There is the natural human tendency to extrapolate recent events. So when a cyclical stock like a steel company or property developer has a few tough years, investors tend to make the assumption that the bad times will last indefinitely. This can sometimes offer good opportunities for the canny investor.
In the same way, when these stocks show a few years of good results, thanks, for example, to strong Chinese metal demand, a booming property market or some other factor, the market tends to extrapolate the good times. It's the same mistake made at different ends of the cycle. Just at the peak of a cycle, investors can confuse a cyclical stock with a growth stock and bid the shares up, perhaps to a very high PER. But when earnings are at a peak, that's exactly when cyclical stocks should be selling on a low PER. When earnings fall, as they inevitably do with a cyclical downturn, the shares come crashing down. Farmers-who are used to the feast/famine cycle of a life on the land-seem less susceptible to this folly than most.
6. Follow overly acquisitive management
In his comprehensive book, Two Centuries of Panic , Trevor Sykes says that 'more companies are ruined by bad management than by bad economies'. We'd most definitely agree. Overly acquisitive managements-those hell-bent on growth, seemingly at any cost, are especially prone to getting into trouble. How so?
Acquisitions often involve large amounts of debt which thereby increase risk. As interest rates rise, for example, a growing portion of cashflow has to be diverted to service debt rather than deployed in the business or paid out as dividends. Secondly, acquisitive managements, often suffering from delusions of grandeur, can overstretch themselves. And, finally, acquisitions tend to cloud the company's financial accounts. This can fool bankers and shareholders for a while but by the time the gravity of a tough situation comes to light, it's too late. The collapse of speedily built empires like Austrim, Quintex and Adelaide Steamship are stark reminders of what can go wrong. Backing such management is almost bound to help lighten your wallet.
7. Invest in rapidly expanding financial institutions
Depending on the riskiness of the borrower, a financial institution might make a 'spread' or 'margin' on loans of anything from 1% to 5% per year. But when a loan goes bad, it can lose 100%. It's a risk that must be managed very, very carefully. Warren Buffett once remarked that a bad bank manager can flush all your equity down the toilet in your lunch hour.
And watching the accounting ratios like a hawk won't always save you either. In banking, growth can actually be used to hide bad loans temporarily (as, perhaps, we are about to see). A bank that is experiencing a high rate of loan delinquencies can easily halve that rate temporarily by writing new loans and doubling the size of its loan book-after all, a new loan takes time before it can go bad. But hastily made new loans are likely to be of poorer quality than existing ones.
This is why we get worried when financial institutions aim for rapid growth. Bank of Queensland, on which we have a negative recommendation, has targeted a 5% share of the national home loan market in 3-5 years, compared to its current 2.5% share. To achieve that, we suspect it will have to offer lower rates, or take on riskier business, to wrestle market share from the other banks-especially as it tackles markets outside its home state. If you want to improve your chances of ending up in the financial poorhouse, put your money into fast-growing financial institutions.
8. Work to the 'greater fool' theory
Some investors seem happy to buy expensive stocks, knowing full well they're overvalued, because they feel confident that someone else will come along and pay an even higher price. That's what happened in the dot com boom and it's what seems to be happening in the current nickel boom. Many investors buying nickel stocks now believe them to be overvalued, but assume they'll get even more overpriced-as in the Poseidon boom of the early 1970s. It's financial musical chairs for suckers and is likely to end up costing many investors a bundle.
9. Buy 'gunna' companies rather than 'doer' companies
'Gunna' companies are those that are 'gunna' do this and 'gunna' do that. Such unproven companies, and their attendant management teams, are a great way to lose capital. But even well-established companies can be 'gunna' companies. Management will explain away the poor performance of the last few years and concentrate on what it will do in the future. Chances are it will be putting on a similar show a few years down the track. While those sticking with proven companies and managements should do well, if you're aiming to lose money, buy 'gunna' companies.
http://shares.intelligentinvestor.com.au/articles/140/Golden-rules-for-losing-money.cfm#.UkN5yssayK1
To make money, sometimes it's better to first concentrate on not losing it.
Investing successfully poses many challenges. Here are some of the techniques that can help you to rise to these challenges but first, one of our favourite tools, from mathematician Carl Jacobi.
He was fond of saying, 'invert, always invert' and that's what we're going to do here. Instead of looking at how to make money, we're going to look at great ways to lose it. That way you can aim to minimise your mistakes-a vital part of investing successfully.
So here they are, classic investment mistakes guaranteed to ensure woeful performance.
1. Trade fast and trade often
Charlie Munger, Warren Buffett's business partner, often refers to the huge mathematical advantages of 'doing nothing' to your portfolio. Let's blindly ignore the very large tax benefits of holding stocks for the long term and just consider the impact of brokerage.
Someone who 'turns over' (buys and sells) all the stocks in their portfolio several times a year is at least a few percent behind the eight ball, even with internet brokerage rates as low as 0.3%. Add up the brokerage from your last tax return to see what we mean.
There's also an important, but less measurable, benefit to taking a longer-term approach. It makes you think long and hard about which stocks to include in your portfolio. When you are considering buying a stock for 10 years or more, you tend to pick quality businesses. And that can only be a good thing.
So, if your intention is to lose money (and enrich your broker), trade fast and frequently.
2. Follow the mainstream media
Hopefully, you are somewhat against this particular human folly. Most people, though, aren't so resistant.
Munger refers to a human condition known as 'incentive-caused bias' and it explains the functioning of media quite nicely. There's a widely held belief, and it may be correct, although declining newspaper circulations suggest otherwise, that emotional, confrontational, dramatic coverage sells more papers than rational, factual reporting. Hence the tendency to induce panic in investors when calmness would better serve their interests.
But incentive-caused bias doesn't just affect the media. Just look at how honest managing directors can first convince themselves, then their board, then their shareholders, how an offshore acquisition or hostile takeover will be great for everyone, especially themselves. Generous options packages offer a fitting explanation for many examples of corporate foolishness.
To lose money, avert your eyes from a factual assessment of a situation and bury yourself in the opinions and arguments of those with a vested interest in convincing you of the veracity of their own opinion.
3. Follow fads or 'hot stocks'
In his highly recommended book Influence: The Psychology of Persuasion , Robert Cialdini talks about another human condition known as 'social proof'. The evolution of the human species, and sheep, was greatly assisted by a tendency to follow the crowd-safety in numbers and all that.
Anyone who thinks that social proof is solely the preserve of the historian should study the mania of the dot com boom. Millions, gulled with the fear of standing apart from the crowd, played a huge role in firing the mania. Conformity still dictates many areas of life but following the stockmarket crowd can be a costly mistake. As Buffett says, 'you pay a very high price in the stockmarket for a cheery consensus.'
That's why we are most often excited when others are depressed and fearful when others are optimistic (see our review of FKP on page 6). And it explains why we're worried about China, nickel stocks and other areas like the spate of listed investment company floats that are currently running hot.
If you're intent on seeing your net worth dwindle, follow hot stocks and sectors.
4. Beat yourself up over lost opportunities
'Right decision, wrong result'. In an imperfect activity like investing, mistakes are absolutely inevitable. But, odd as it may sound, sometimes even when you're right, you're wrong.
To call tech stocks overvalued in mid-1999 was undoubtedly correct. But for the next six months, as speculators pushed prices higher still, it sure didn't feel correct. It's a fact of life that someone will always be getting rich a little quicker than you are. But then again, they may become poor just as quickly by adopting the same approach.
If you take the conservative decision not to invest in a stock, and it goes up anyway, don't fret. Just be patient-other opportunities are often just around the corner. But if you are interested in blowing your capital, now's a good time to capitulate and buy at these higher prices.
5. Buy cyclical stocks at the top
There is the natural human tendency to extrapolate recent events. So when a cyclical stock like a steel company or property developer has a few tough years, investors tend to make the assumption that the bad times will last indefinitely. This can sometimes offer good opportunities for the canny investor.
In the same way, when these stocks show a few years of good results, thanks, for example, to strong Chinese metal demand, a booming property market or some other factor, the market tends to extrapolate the good times. It's the same mistake made at different ends of the cycle. Just at the peak of a cycle, investors can confuse a cyclical stock with a growth stock and bid the shares up, perhaps to a very high PER. But when earnings are at a peak, that's exactly when cyclical stocks should be selling on a low PER. When earnings fall, as they inevitably do with a cyclical downturn, the shares come crashing down. Farmers-who are used to the feast/famine cycle of a life on the land-seem less susceptible to this folly than most.
6. Follow overly acquisitive management
In his comprehensive book, Two Centuries of Panic , Trevor Sykes says that 'more companies are ruined by bad management than by bad economies'. We'd most definitely agree. Overly acquisitive managements-those hell-bent on growth, seemingly at any cost, are especially prone to getting into trouble. How so?
Acquisitions often involve large amounts of debt which thereby increase risk. As interest rates rise, for example, a growing portion of cashflow has to be diverted to service debt rather than deployed in the business or paid out as dividends. Secondly, acquisitive managements, often suffering from delusions of grandeur, can overstretch themselves. And, finally, acquisitions tend to cloud the company's financial accounts. This can fool bankers and shareholders for a while but by the time the gravity of a tough situation comes to light, it's too late. The collapse of speedily built empires like Austrim, Quintex and Adelaide Steamship are stark reminders of what can go wrong. Backing such management is almost bound to help lighten your wallet.
7. Invest in rapidly expanding financial institutions
Depending on the riskiness of the borrower, a financial institution might make a 'spread' or 'margin' on loans of anything from 1% to 5% per year. But when a loan goes bad, it can lose 100%. It's a risk that must be managed very, very carefully. Warren Buffett once remarked that a bad bank manager can flush all your equity down the toilet in your lunch hour.
And watching the accounting ratios like a hawk won't always save you either. In banking, growth can actually be used to hide bad loans temporarily (as, perhaps, we are about to see). A bank that is experiencing a high rate of loan delinquencies can easily halve that rate temporarily by writing new loans and doubling the size of its loan book-after all, a new loan takes time before it can go bad. But hastily made new loans are likely to be of poorer quality than existing ones.
This is why we get worried when financial institutions aim for rapid growth. Bank of Queensland, on which we have a negative recommendation, has targeted a 5% share of the national home loan market in 3-5 years, compared to its current 2.5% share. To achieve that, we suspect it will have to offer lower rates, or take on riskier business, to wrestle market share from the other banks-especially as it tackles markets outside its home state. If you want to improve your chances of ending up in the financial poorhouse, put your money into fast-growing financial institutions.
8. Work to the 'greater fool' theory
Some investors seem happy to buy expensive stocks, knowing full well they're overvalued, because they feel confident that someone else will come along and pay an even higher price. That's what happened in the dot com boom and it's what seems to be happening in the current nickel boom. Many investors buying nickel stocks now believe them to be overvalued, but assume they'll get even more overpriced-as in the Poseidon boom of the early 1970s. It's financial musical chairs for suckers and is likely to end up costing many investors a bundle.
9. Buy 'gunna' companies rather than 'doer' companies
'Gunna' companies are those that are 'gunna' do this and 'gunna' do that. Such unproven companies, and their attendant management teams, are a great way to lose capital. But even well-established companies can be 'gunna' companies. Management will explain away the poor performance of the last few years and concentrate on what it will do in the future. Chances are it will be putting on a similar show a few years down the track. While those sticking with proven companies and managements should do well, if you're aiming to lose money, buy 'gunna' companies.
http://shares.intelligentinvestor.com.au/articles/140/Golden-rules-for-losing-money.cfm#.UkN5yssayK1
Wednesday 18 September 2013
The Twelve Silliest (and Most Dangerous) Things People Say About Stock Prices
1. If it's gone down this much already, it can't go much lower.
2. You can always tell when a stock's hit bottom.
3. If it's gone this high already, how can it possibly go higher?
4. It's only $3 a share: What can I lose?
5. Eventually they always come back.
6. It's always darkest before the dawn.
7. When it rebounds to $10, I'll sell.
8. What me worry? Conservative stocks don't fluctuate much.
9. It's taking too long for anything to ever happen.
10. Look at all the money I've lost: I didn't buy it.
11. I missed that one, I'll catch the next one.
12. The stock's gone up, so I must be right, or ... The stock's gone down so I must be wrong.
Reference:
One Up on Wall Street by Peter Lynch
2. You can always tell when a stock's hit bottom.
3. If it's gone this high already, how can it possibly go higher?
4. It's only $3 a share: What can I lose?
5. Eventually they always come back.
6. It's always darkest before the dawn.
7. When it rebounds to $10, I'll sell.
8. What me worry? Conservative stocks don't fluctuate much.
9. It's taking too long for anything to ever happen.
10. Look at all the money I've lost: I didn't buy it.
11. I missed that one, I'll catch the next one.
12. The stock's gone up, so I must be right, or ... The stock's gone down so I must be wrong.
Reference:
One Up on Wall Street by Peter Lynch
Sunday 15 September 2013
Saturday 17 August 2013
New information is interpreted, and not all of that interpretation is rational. (Behavioral Finance)
Psychological research in behavioural finance dispute the idea that investors act as dispassionate calculating machines.
It turns out that like everyone else, investors respond to events in the world with certain powerful biases.
New information is interpreted, not simply digested, and not all of that interpretation is rational.
One powerful set of biases tends to give more significance to the most recent news, good or bad, than is actually warranted. The stocks of companies that report high rates of growth are driven to extremes, as are stocks of companies that disappoint. (Recency bias).
These findings about excessive reactions confirm a belief that value investors have held since Graham: Over the long run, performance of both companies and share prices generally reverts to a mean.
"Many shall be restored that now are fallen and many shall fall that now are in honor."
Thursday 1 August 2013
Think Like the Great Investors: Make Better Decisions and Raise Your Investing to a New Level
From Wikipedia, the free encyclopedia
Risk aversion is a concept in psychology, economics, and finance, based on the behavior of humans (especially consumers and investors) while exposed to uncertainty to attempt to reduce that uncertainty.
Risk aversion is the reluctance of a person to accept a bargain with an uncertain payoff rather than another bargain with a more certain, but possibly lower, expected payoff.
Summary:
Due to risk aversion:
1. The "investor" did not invest into stocks for fear of short term losses, despite knowing that stocks provide better returns than cash or bonds in the long run..
2. The "investor" sold his winners too early to avoid losses..
3. The "investor" hung onto his losing stocks, in the hope that the prices will recover and thereby avoiding realising his losses.
In all the above ways, the motivation is fear, which results in poor decision making..
Early research by Daniel Kahneman and Amos Tversky found people place greater value on avoiding losses than on making gains.
Not only that, but they prefer a small certain gain to a larger potential one.
Nicholson says investing should be managed like a business.
Some decisions work out and some don't: if an investment doesn't work, sell; if it works, let it continue.
Unfortunately, most people do the reverse.
''The most valuable thing I have learnt over more than 30 years of investing in stocks is that great investors think differently. They understand that investing is about managing uncertainty,''
######################
Decision making in a sideways market
Date July 31, 2013
Barbara Drury
Shakespeare wrote that life was a tale told by an idiot, full of sound and fury, signifying nothing. He could have been writing about the sharemarket - up one day, down the next, going nowhere. And that leaves investors in a quandary.
Most investors understand that shares provide better returns in the long run than cash or bonds, but the fear of short-term losses stops them acting on it. When markets are choppy with no clear direction, investors tend either to hesitate on the sidelines and miss opportunities, or sell too early to avoid a loss.
Either way, the motivation is fear, which results in poor decision making. ''The most valuable thing I have learnt over more than 30 years of investing in stocks is that great investors think differently. They understand that investing is about managing uncertainty,'' professional investor Colin Nicholson says. In his latest book, he discusses the common decision-making traps investors fall into and how to avoid them, drawing on the field of behavioural finance. Early research by Daniel Kahneman and Amos Tversky found people place greater value on avoiding losses than on making gains. Not only that, but they prefer a small certain gain to a larger potential one.
Further behavioural finance studies have found that an aversion to losses caused people to sell their winning stocks too early and hold their losers too long in the hope the share price would recover. Nicholson says investing should be managed like a business. Some decisions work out and some don't: if an investment doesn't work, sell; if it works, let it continue. Unfortunately, most people do the reverse.
Advertisement
''We are in a sideways market at the moment, which is the most difficult of all to invest in,'' Nicholson says. ''Any fool can make money in a rising market. And if investors are half-smart they can avoid falling markets. But in a sideways market you need to be a stock picker and you need to preserve capital.''
A practical way to achieve this is to use stop losses. Nicholson says the key attributes of great investors are patience, discipline and perspective. ''People get caught up in the psychology of the crowd,'' he says. ''If you can step back and get some perspective it helps.''
Reading about market history is helpful, but before you invest you need a plan.
''One of the ways to deal with inertia and fear is to have a written investment plan that sets out how you select stocks and manage your investments, so no matter what the market throws at you, you know what to do,'' Nicholson says.
Think Like the Great Investors: Make Better Decisions and Raise Your Investing to a New Level, by Colin Nicholson, 2013, Wiley.
Read more: http://www.smh.com.au/money/decision-making-in-a-sideways-market-20130730-2qvhe.html#ixzz2ahFdpHNZ
Wednesday 31 July 2013
The importance of understanding your own behaviours in relation to your actions in investing; once understood, you will be able to apply your preferred investing style consistently without emotional or psychological bias.
The person capable of standing back may notice that change is the one constant.
One might do well to stand back and consider whether a perceived truth is indeed so, or whether in fact the more things apparently change, the more some things do indeed remain the same.
Following the crowd and abandoning a commitment to a long-term approach in a business you bought into believing it to be sound could lead to a real loss, especially if, six months later, it turns out that the crowd consisted of ill-informed speculating lemmings and now the shares you sold have doubled in value as sanity returned to the market.
The importance of understanding your own behaviours in relation to your actions cannot be over-stated.
Once understood, you will be able to apply your preferred investing style consistently without emotional or psychological bias. Something which is easier said than done.
One might do well to stand back and consider whether a perceived truth is indeed so, or whether in fact the more things apparently change, the more some things do indeed remain the same.
Following the crowd and abandoning a commitment to a long-term approach in a business you bought into believing it to be sound could lead to a real loss, especially if, six months later, it turns out that the crowd consisted of ill-informed speculating lemmings and now the shares you sold have doubled in value as sanity returned to the market.
The importance of understanding your own behaviours in relation to your actions cannot be over-stated.
Once understood, you will be able to apply your preferred investing style consistently without emotional or psychological bias. Something which is easier said than done.
"An optimist will tell you the glass is half-full;
the pessimist, half-empty; and
the engineer will tell you the glass is twice the size it needs to be."
Monday 29 July 2013
One of the biggest dangers with Investing is Overconfidence
Quote:
Re: uyafr selection October 2010 batch
« Reply #45 on: October 27, 2010, 10:16:15 AM »
Reply with quoteQuote
Quote from: smartinvestor on October 27, 2010, 10:09:42 AM
Agree with Uyfar...
GenY...please tell the MANY company that also doing well too...
DIGI? KPJ? Genting?
Here is the place we share information and earn $$$ together
yep, do u know how much is DIGI, KPJ Gentings ? hehehe if suddenly those counter drop.. kena kaw kaw, if go up.. the most 5-10%
BUT LCTH, I dont see how it can drop much, but if go up... even if go up 100% it is still cheap and good. So think for yourself, is it worth risking on those counter already too high up or buy a counter which is still rock bottom and rock solid.
http://www.investlah.com/forum/index.php/topic,11510.msg195753.html#msg195753
The above was a post in October 2010 in a blog that I participate.
Here are the 5 Years charts of DIGI, KPJ, Gentings and LCTH performance.
Digi Share Price
Oct 2010 RM 2.50
July 2013 RM 4.70
Capital Gain 88%
KPJ Share Price
Oct 2010 RM 3.80
July 2013 RM 6.50
Capital Gain 71%
Genting Share Price
Oct 2010 RM 10.50
July 2013 RM 10.50
Capital Gain 0%
versus
LCTH Share Price
Oct 2010 RM 0.28
July 2013 RM 0.18
Capital Loss - 35.7%
From October 2010 to July 2013:
1. The prices of the shares of Digi, KPJ have performed very well.
2. Genting share price remained relatively unchanged over this period.
3. The share price of LCTH has tanked significantly.
Questions I pose:
1. Are higher priced stocks more risky than penny shares?
2. Are higher priced stocks more risky because they have a longer way to drop?
3. Are penny shares less risky because should their prices correct, the drop will be less?
4. Why are higher priced stocks priced such, and why are penny stocks priced such?
5. What are the fears that kept this "investor" away from Digi, KPJ and Genting? Are these fears rational or irrational?
6. What drives his enthusiasm to penny stocks? Greed? Ability? Confidence? Past gains? Are these emotions rational or irrational?
7. What single characteristic, if any, distinguishes the gains in Digi, KPJ and no loss in Genting, compared with LCTH?
What lessons can we derive from the above observations?
Please feel free to post your comments.
Tuesday 2 April 2013
Friday 5 October 2012
Cognitive Biases That Cause Bad Investment Decisions
Henry Stimpson
Published: Tuesday, November 29th 2011
When it comes to investing, you might think your emotions don’t play a role, but they do without you even realizing it. Everyone has emotional and cognitive biases that shape their choices, and only by spotting them can you overcome them so they don’t cause bad investment decisions, according to Ben Sullivan, a certified financial planner at Palisades Hudson Financial Group.
Sullivan recalls a number of clients who have made mistakes in the past. A middle-aged banker had more than half of his $500,000 portfolio in a few bank stocks. Another prospective client sold his business to a big consumer-goods company had almost all his money — many millions — in that company’s stock. An employee believed his 401(k) plan was diversified because he owned four funds — all large-cap stock funds.
“Investor mistakes have predictable patterns,” says Sullivan. “Our pervasive emotional and cognitive biases often lead to poor decisions.”
Overconfidence
It’s easy to overestimate your own abilities in picking stocks while underestimating risks. Even professional money managers struggle to beat index funds. The casual investor has little chance, Sullivan says.
“It’s almost impossible to have a day job and moonlight as manager of your individual-stocks portfolio,” he says. “Overconfidence frequently leaves investors with their eggs in far too few baskets, with those baskets dangerously close to one another.”
Self-attribution
This is a cognitive error leading to overconfidence. Someone who bought both Pets.com and Apple in 1999 might dismiss his Pets.com loss (it went bankrupt) because the market tanked but believe he’s an investment whiz because he bought Apple.
Familiarity
Investing in what you “know best” can be a siren song leading investors astray from a prudently diversified portfolio. That was the case with all three investors mentioned above. They were familiar with banks, consumer goods and large-cap U.S. stocks respectively, Sullivan says, and unwisely put all their eggs in that familiar basket.
Anchoring and loss aversion
Investors may become “anchored” to the original purchase price. Someone who paid $1 million for his home in 2007 may insist that what he paid is the home’s true value, even though it’s really worth $700,000 now. The same holds for securities.
“Only the future potential risk and return of an investment matter,” Sullivan says.
Inability to sell a bad investment and take a loss causes investors to lose more money as the hoped-for recovery never happens.
“You’ll also miss the opportunity to capture tax benefits by selling and taking a capital loss,” he adds.
Herd fever
When the market is hot and high, the media and everyone else say buy. When prices are low — remember March 2009 — everyone says sell. Following the herd leads investors to come late to the party so that they’re buying at the top and selling at the bottom. Following the herd is a powerful emotion.
Today, Sullivan says, the herd is buying gold and U.S. Treasuries.
Recency
According to a study by DALBAR Inc., the average investor’s returns lagged those of the S&P 500 index by 6.5% per year for the 20 years prior to 2008 largely because of recency bias. People invested in last year’s hot funds, which often turn sour next year, instead of taking a steady course, he says.
(Ed: Read about how the recency effect has been influencing the housing market.)
Counteracting your biases
Having a written plan is the key, Sullivan says.
“Create a plan and stick to it,” he says.
Hewing to a written long-term investment policy prevents you from making haphazard decisions about your portfolios during times of economic stress or euphoria. Selecting the appropriate asset allocation will help you weather turbulent markets.
All investors should invest assets they will need to withdraw from their portfolios within five years in short-term liquid investments. Combining an appropriate asset with a short-term reserve gives investors more confidence to stick to their long-term plans, he says.
If you can’t control your emotions — or don’t have the time or skill to manage your investments — consider hiring a fee-only financial adviser, Sullivan says. An adviser can provide moral support and coaching, which will boost your confidence in your long-term plan and also prevent you from making a bad, emotionally driven decision.
“We all bring our natural biases into the investment process,” Sullivan says. “Though we cannot eliminate these biases, we can recognize them and respond in ways that help us avoid destructive and self-defeating behavior.”
Tuesday 2 October 2012
Investment Risks Rooted In Human Behavior
Investment Risks Rooted In Human Behavior
BY HUGH MASSIE ⋅ MARCH 5, 2009
A statement I have been making to many people for the last 10 years is: “Investment markets cannot be controlled, but how you manage your reaction to them can be”.
Generally, for most investors the reason that they obtain returns which are on average 6% lower than market returns is because of their behavior. Investors generally make poor investment decisions because of their reactions to events and also to their own life circumstances. This can be because they do not know who they are or how to manage their emotional impulses which are driven from how they are wired to behave. I really want to emphasize that successful investing is about managing your behavior.
If you are an advisor, it is about predicting and managing your client’s behavior and also managing your own behavior. So when you talk about managing investment risk, what you are really talking about is managing BOTH human behavior and the market risks. This is fundamental to the value proposition for obtaining advice from an advisor. Clearly, it is important that the advisor also has a high degree of financial emotional intelligence.
Traditionally, when risk is talked about in investing, everyone talks about market risks and to some degree investor risk tolerance. The reality is that there are so many more risks which need to be addressed which all have an impact on the investment decisions made. These additional risks are behavioral. To make the point, I have prepared the following table which highlights many of the “Investment Impact Risks” that can influence investment decisions and ultimately the investment returns a person achieves. This is what needs to be managed.
So, there is a very strong case for every person to have behavioral guidance from an advisor no matter how knowledgeable or experienced they are with investments. The behavioral guide or what we call a “wealth mentor” needs to have a true understanding of a person’s Financial DNA which is their financial behavioral style. The Financial DNA is shaped from genetics, early life experiences and then overall life experiences, values and education. At a broad level, the behavioral information that needs to be discovered is in the following categories of information, as they all impact the investment decisions made in some way.
The reason we advocate that investors and advisors (the behavioral guide) complete behavioral profiles early in the advisory process is because they provide objective and measurable insights into the complete financial behavioral style on a holistic basis. With a good behavioral profile, not only is the risk tolerance discovered, but also completely who the person is at a much deeper level than what any normal person can reliably do on their own. You truly get below the surface. Remember, no matter how evolved you are personally, we all have blind spots and biases. Very often clients “eat” the behavior of the advisor. So, the advisory process becomes dangerous if the advisor is not aware of his or her blind spots.
Which ever angle you come from they all lead to the point that investment risks are rooted in human behavior.
Friday 21 September 2012
Stung by Losses, Main Street Investors Fail to Notice Market's Rebound
By Karen Weise on September 19, 2012
Although the memory of Lehman Brothers’ 2008 collapse may be fading on Wall Street, the shock still lingers on Main Street—and may again be hurting ordinary investors. A new survey of individual investors is a reminder of just how much we are primal creatures that remember the pain of loss more than the joy of gains.
As my colleague Roben Farzad recently reminded us, the Standard & Poor’s 500-stock index is on a tear, rallying on rising corporate profits (including Apple’s (AAPL)earnings bonanza) and optimism about further help from the Federal Reserve. Since its nadir in March 2009, the S&P 500 has more than doubled and is now at 1,463, not that far from the all-time high of 1,526 it reached in September 2007.
But ask Main Street investors, and you find that the market isn’t all roses: Memories of the steep losses from 2008 and 2009 still haunt, causing them to underestimate the market’s performance.
Franklin Templeton (BEN) surveys individual investors annually, asking how they perceive the market’s performance in the previous year. In 2010, 66 percent of investors said the S&P had fallen in 2009, when it actually had gained 26.5 percent—in a year following a steep 37 percent plunge. In 2011, 48 percent of investors said the markets were down over the course of 2010, when the S&P had risen more than 15 percent. And data just released on Sept. 18 shows that 53 percent of investors think the S&P declined in 2011, when the index actually rose 2 percent.
It’s fair to wonder if investors who don’t know whether the S&P made or lost money the prior year are sufficiently attuned to the market to risk cash in it. However, Franklin Templeton’s survey is also a marketing exercise—the company is a major mutual fund seller that would like to help guide you into investing.
The S&P has gained more than 16 percent so far this year, but that’s no reason to to think investors have suddenly overcome their post-crash trauma. They have continued pulling out of equities, taking more than $66 billion (XLS) out of the U.S. stock market in 2012.
This fear of getting burned again—“loss aversion,” in financial psychology lingo—means that Main Street is being hit by a double whammy. Not only did individual investors take a beating when the market tanked, they’re not benefiting from its rebound, either.
Weise is a reporter for Bloomberg Businessweek.
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