The more you know about your psychological biases, the better you can function in the volatile stock market.

Everyone has opinions and psychological biases.  However, people may not know their own biases.

The more you know about your psychological biases, the better you can function in the volatile stock market.

The entire market may be influenced by psychological reasons, not by fundamental reasons alone.

From an investment perspective, the bottom line is that the market will continue to fluctuate and give you solid opportunities every so often.

Value in the long run is determined by fundamentals, while short-term gyrations reflect market participants' psychological weaknesses, such as herding.  

Knowledge is the best antidote to making wrong decisions.

If you are a long-term investor, the rational thing to do is to make decisions based on long-term fundamentals of the business.

Major psychological factors that can make an investment strategy make or break.

Investor behavior is irrational as a result of psychological biases. 

Risk aversion, fear, or over-confidence, are the major psychological factors that can make an investment strategy make or break.

With the help of Behavioral Finance, stock market theorists, finance managers, equity analysts and anyone involved in stock market analysis can identify

• how investors evaluate certain events and 
• react in stock market changes. 

Also, investors can understand and evaluate market changes gaining a broader understanding of the factors that drive their behavior.

The barriers to success are psychological rather than physical.

What can an individual investor do?

Though it is believed that investment can be a  very profitable field, it is only profitable to those who are strong of will and are prepared to work at it.  There is no simple way to get rich quick in the stock market. 

The barriers to success are psychological rather than physical.   Psychological barriers are so much harder to cross for so few of us can bear the thought of not being part of a crowd. 

Here are the words of advice from Dreman in his book Psychology and the Stockmarket. 

"....  the best chance an investor has is to stand apart from popular thinking.  He must be willing to forego the thrill of being in unison with the market, in agreement with the expert opinion and with the exciting, seemingly surefire ideas currently in vogue....  This is no small sacrifice.  To own the 'right' stocks in a rising market is a heady experience.  There is a wonderful blend of monetary gain and ego satisfaction in being right in a popular manner. 

Man is a social animal.  To succeed, the investor has to be able to withstand the tremendous pressure leading to conformity... (he) will face a continuing flow of negative feedback from the market, from experts and from groups of people whom he respects.  The reader may feel a little like the patient whose doctor has advised him to give up sex for this health.  Some of us might just prefer to die happy."

Greed and Fear

Thursday, September 17, 2009


Greed and Fear



I have been noting down on my emotions : When I was greedy, when and why? When I was in fear, when and why?



How I survived a nightmare(day-mare, actually)



ZiJin-cw : Yesterday, I queued for 0.148 and it was done. Shouldnt I be jumping for joy after TWICE it shot up above 0.14(my target price) to 0.144 and 0.142, only to see it pullback the next day to go below 0.130?! Should I be relieved that I could sell it at such a "HIGH" price as I saw it plummeted to a low of 0.07 last month?? I was not in joy after I sold it, as I m seeing more upside on it TODAY as gold reaching for 1020. Now, yesterday morning it was at 1005(and even went down to 990 level days ago!!) ... so, I do know it will jump, and placing a 25% increment from the previous closing price, I thought it wont be done(like I dont wish to sell? GREED in play) ... cool. It closed at 0.155. OUCH. Later I wont be surprise if it jumps up another 10-20% to 0.17 level, and breaching new high above 0.20 soon. SHOULDNT I BE in JOY? Hmmm ...



Now, for TWO times when it breached my target price at 0.140 ... I got GREEDY and did not sell it at 0.140(lack of discipline with GREED in play). But, both of the times, it dived below 0.130 the next few trading days. I was cursing myself for not being disciplined. I SHOULD HAVE SOLD IT AT 0.140, I said. As it reached 0.125 level(FEAR in play?), I was kicking myself(in my trading room ... without anyone know about it, and also I do not write about it. This is a confession of a novice trader!) ... and promised to sell it at 0.140 the next time. Yesterday, it breached 0.140 for the third time in as many weeks.



I bought ZiJin-cw at 0.142 with great confidence it will shoot up back to 0.20 level(it dived from 0.16+ to 0.14 level when I decided to buy into it). For first few days, it went up to 0.150. I started to feel confident. I even think of buying more?? GREED in PLAY. But, I did not as that was not in my trading plan. As China markets pullback, ZiJin started to show weakness and back to 0.140 level, and without much problem, going below 0.130 after a week or so!! I do not put a stop-loss, but thought of buying more at 0.120 level.



Yes, it reached 0.120 level ... I was in FEAR and was too stunned to execute my plan? Hello novice trader, you are supposed to follow your plans? I did not. It went back to 0.130 level ... then, HAI YAH, why I didnt buy at 0.120 as planned? It it going to shoot up 0.15 soon!! Yeah, right. Emotions in play ...



Funny, it dived below 0.120 level ... and I was watching it and braved myself : You better buy at 0.10 level or else I will slap you. PIAK. I bought more at 0.10, to avoid being slapped by myself.



FEARS? Wait till you see my face when it went below 0.10, and dived to 0.07 level. I will buy at 0.05 level, I mumbled. Yeah right ... when it really reached 0.05 level, we will be shivering??! I was holding on to 180k units averaging at around 0.12, so at 0.07 ... I m losing almost half of my values. With the expiry date shorten each day, the FEAR is very real. What should I do? As I searching for answers(like looking at my palm lines and the formation of stars above) ... ok, last plunge to 0.05 ... BUY!



It rebounded from 0.07 very quickly back to 0.10 level. PHEW!! What a relieve tho I was still down. As markets in HK recovering, gold price shooting higher to 980 level ... wow. Suddenly there is a great interest in ZiJin. It was shooting like 20% per day. Do the calculations : 0.070 to 0.100, the 0.120. That was just in a week!! It reached my average price. What a relief. Suddenly the FEAR disappear(very fast) and confidence is back. Ok ... I will be VERY glad to clear it at 0.140, I told myself.



Arrghh ... it did reach 0.14 ... ok, I think it will reach higher, say to 0.15?? Then, I started to write about it 2/3 weeks ago, exposing my rollercoaster ride with it. Well, it reached 0.140 TWICE but finally I sold it yesterday as it reached 0.140 again for the third time.



ZiJin breached HKD8 yesterday to close at 8.15, a level never expected in such a short period of time. I started to stalk ZiJin in Feb when it was at HKD3.50 level.



There are so much emotions involved that I was numbed. I m learning to ride on roller-coasters and to numb myself when I trade. But, frankly ... I dont like the emotions in play. I wish I m totally emotionless. Guess I just need to learn and experience more ... I m such a novice. HAHA.



I m trying to be a contrarian but due to lack of discipline, I have not really been doing that. I tend to 'follow the herd', and being slow, I will be slaughtered. The control of emotions is VERY essential and important. Move on after we sell(not looking back with regrets due to greed) ... and hold on after we bought it. Markets up and markets down ... it is the trend that we should TRY to follow. As the saying goes, market ALWAYS win. We buy, it goes down ... we sell, it shoots higher. It is wiser to be longer term investor rather than short-term trader if we could not contain our emotions.



NOTE : The above story is fictional as it is being used to illustrate FEAR and GREED in a novice trader like me and should not be taken seriously.

http://cpteh.blogspot.com/

Your Brain and Investing

Your Brain and Investing


by Adam Ritt

Most investors are their own worst enemy. They buy high and sell low, allow the herd to dictate their decision-making and get caught up in the day-to-day movements of the market. The relatively new field of neuroeconomics, which studies how people make choices, helps explain why the market is anything but rational.

BetterInvesting recently spoke with Jason Zweig, author of the new book Your Money & Your Brain, about his research on neuroeconomics and what we can do to keep our worst impulses in check. Zweig is a senior writer for Money magazine and was also the editor of the revised edition of Benjamin Graham’s The Intelligent Investor. He serves on the editorial boards of Financial History magazine and The Journal of Behavior Finance.

How did researching this book change your views of investing?

The first and most important thing that came out of this is that it’s very comforting to find new proof of old truths. There’s very little I’ve changed about my own investing approach and not much I’ve changed about the investing advice I continue to give people.

The second principle that I took away from it is that people are unaware of how great an influence the unconscious mind holds over our decisions. I tell the story in the book about a doctor who buys a stock just because it has the same ticker symbol as his initials. There’s actually a whole field of research into this area, which psychologists call implicit egotism. It’s the idea that completely unconsciously, people favor things that are closely associated with themselves.

We often don’t know the real reason we’re doing things, and that can lead us to think we understand our decisions when in fact they never really were decisions in the first place. They were just ideas that came to us, and we didn’t really know why, but they felt right and we acted on them. This is what (author) Malcolm Gladwell calls “blink.” That’s a very good idea if you’re in a battle and you’re being shot at. If you think you should duck, you should. But it’s probably not such a good idea when you’re investing.

One of the main points of the book is that investors can solve a lot of the problems they’ll have to overcome by shutting out the noise. What are some of the negative effects of the instant availability of information?

If you’re hooked up to a machine that monitors your bodily functions and you watch an online stock ticker going down with a lot of red arrows, or you watch some CNBC show with some funny-looking man waving his arms and screaming, your blood pressure will go up, your pulse will climb, you’ll start breathing faster. Your temperature will rise, you’ll turn red in the face, you’ll sweat. Depending on how severe it is, you might be aware of the anxiety you’re feeling. Or it might not register in your conscious mind; it might just be a slight uptick in your body tension. But all it takes is a tiny change in your normal body state to skew your response.

If we take someone who’s mildly upset and ask him to sell a stock, he’ll accept a lower price than someone who’s in a neutral or positive mood. The evidence is overwhelming that paying attention to negative news does change your body, and when your body changes, your brain changes with it. This naturally inclines you toward making short-term-oriented decisions, panicky decisions and bad decisions.

It’s hard to say what the single worst thing an investor can do is, but my vote would probably be to pay close attention to the market news. Even if it’s good news, it will prompt you into doing things that are bad for you. And if it’s bad news, it will prompt you into doing things that are terrible.

Your underlying message seems to be to just follow a company’s fundamentals.

You really have to ask yourself, “What is the information that I would get from instantaneous sources that no one else would get before I got it?” Everyone else is watching CNBC, too. Everyone else can click on the same market website that I can.

There are a few reasons people feel the urge to do this. First, we all believe that being informed is better than being uninformed and that information must be inherently a good thing, because we know ignorance is bad.

Second, we tend to ignore what other people are doing. It’s very hard to remember that when you turn on CNBC, there are hundreds of thousands of other people watching at the same time.

We’re also afraid of what will happen if we don’t stay current. But there are experiments showing that when people do stay closely informed on what’s going on in their company, they actually earn lower returns. Because whenever you get news, you assume that it’s worth knowing, and because it’s worth knowing, it must be worth acting on. So if the news is good, you buy, and if the news is bad, you sell, when you actually would be much better off buying and holding (because of all the transaction costs from trading).

The thing to remember is that for the typical large-cap stock, the kind of company likely to be owned by BetterInvesting readers, through any market website you’ll see the price change three to 10 times a minute. Those one- or two-penny changes will register with you, and any time you see motion, your brain is designed to extrapolate from it.

So if a stock has two upticks in a row, you will expect a third. It’s the watching that tends to lead to doing.

Think back to the days when our parents were investing. Unless people lived in a major city, or unless they subscribed to The Wall Street Journal, they often would go for an entire week without being able to update a stock price. I distinctly remember in the 1970s, my dad buying a stock and awaiting the following Friday’s newspaper, because that was the one with the stock prices.

Here’s a simple test: If more information were good for people, then clearly, the returns of the average investor should go up as more information becomes available. But in fact, that’s not what we’ve seen.

In my opinion, the single biggest advantage individual investors have over professionals is that they don’t have to play that game. They can choose to say, “It’s 1:13 in the afternoon, and I don’t care what my stock price is.” If you run a mutual fund, you can’t do that.

Does having a system help us avoid the pitfalls you describe in the book?

Absolutely. Probably the best sentence ever written on investing is Benjamin Graham’s old saying, “The investor’s chief problem — and even his worst enemy — is likely to be himself.” That’s really true. Emotion isn’t always bad, but emotion that’s unchecked by reason usually is bad. It’s nice to have some emotional input into your decisions ... but if all you’re doing is going on your gut feeling, you’re highly likely to be making a mistake. You need to mix your emotions with some analysis.

The way you prevent yourself from being your worst enemy is by putting some policies and procedures in place. What you can do is say, “Well, it’s Jan. 1 or July 1, that’s the time of year when I do my rebalancing, and my target allocation of stocks is 70 percent to 80 percent. Right now I’m feeling nervous, so I’m going to go to the low end of my range.” If your gut feeling tells you the market is cheap, then you can go to the high end of your range.

But the important thing is that you have a range and you honor your own procedures; you don’t break your own rules. Because any time you break your own rules, you’re probably making a mistake.

But at some point, you have to go with your gut, because no system can tell you everything you need to know about a stock.

That’s true, but the key here is to make as few decisions as possible.

It must be hard to maintain discipline when you see the market rewarding stocks that you won’t buy.

It’s very hard. That’s why it’s important to have an investing policy statement, which is the starting point. This essentially explains what your money is for and how in general terms you’ll go about achieving those goals.

But you also need something more specific, a contract with yourself. It needs to be in the form of a checklist, and it needs to say, “I will do this” and “I won’t do that.” You should have it witnessed by a family member or a friend, and you should try to form a little support group of like-minded people.

The important thing is to track your decisions. If — heaven forbid — you break any of your rules, at the time you’re breaking it you have to write down why you’re doing it. Later on, whether the result is good or bad, you have to go back and look at what you said you were trying to accomplish and see whether breaking the rule was worth the trouble.

My prediction is that at least 80 percent of the time, you’ll be sorry you broke your rule.

Common Errors in Decision-Making

The following are some common biases people have, as identified by Max Bazerman of the Harvard Business School. This is adapted from a Babson Staff Letter of Nov. 11, 2005. For the complete article, see BetterInvesting’s February 2006 issue.

Availability: Making decisions on the vividness and recency of information.

Irretrievability: Failing to think beyond a preconceived notion.

The confirmation trap: Unconsciously searching for supporting evidence that we made the right decision.

Insufficient anchor adjustment: Seeing a situation very similar to a past event and interpreting it to mean the same thing will happen this time around.

Hindsight: Changing our evaluation of something or someone after events play out, when we have perfect knowledge.

Regret avoidance: Tending to feel more regret in an act of commission vs. omission. Buyers feel much more remorseful about committing to a purchase and having to live with the decision (be it a good decision or not).

Internal escalation of commitment: Increasing the support of an initial decision over time.

Keys to a Balanced Investing Life

Take the global view. Use a spreadsheet that emphasizes your total net worth — not the changes in each holding.

Hope for the best, but expect the worst. Diversify and learn from market history to help keep you from panicking.

Investigate, then invest. A stock is a piece of a living corporate organism. Study the company’s financial statements.

Never say always. No matter how sure you are that an investment is a winner, don’t put too much of your portfolio in it.

Know what you don’t know. Don’t believe you are already an expert. Ask what might make an investment go down; find out if the people pushing it have their own money in it.

The past is not prologue. Never buy a stock just because it has been going up.

Weigh what they say. Before trying any strategy, gather objective evidence on the performance of others who have used it in the past.

If it sounds too good to be true, it probably is. Anyone who offers high return at low risk in a short time is probably a fraud.

Costs are killers. If you want to get rich, comparison-shop for trading costs and trade at a snail’s pace.

Eggs go splat. So never put all your eggs in one basket.

Adapted from Your Money & Your Brain (Simon & Schuster, 2007) by Jason Zweig.


Adam Ritt, Editor, BetterInvesting Magazine.

http://www.betterinvesting.org/Public/StartLearning/BI+Mag/Articles+Archives/1007cspublic.htm

The risk is not in our stocks, but in ourselves

Risk exists in another dimension: inside you. If you overestimate how well you really understand an investment, or overstate your ability to ride out a temporary plunge in prices, it doesn't matter what you own or how the market does. Ultimately, financial risk resides not in what kinds of investments you have, but in what kind of investor you are. If you want to know what risk really is , go to the nearest bathroom and step up to the mirror. That's risk, gazing back at you from the glass.

What should you watch for?

The Nobel-prize-winning psychologist Daniel Kahneman explains two factors that characterize good decisions:

• "well-calibrated confidence" (do I understand this investment as well as I think I do?)


• "correctly-anticipated regret" (how will I react if my analysis turns out to be wrong?).

To find out whether your confidence is well-calibrated, look in the mirrow and ask yourself: "What is the likelihood that my analysis is right?"


Think carefully through these questions:

• How much experience do I have? What is my track recrod with similar decisions in the past?


• What is the typical track record of other people who have tried this in the past?


• If I am buying, someone else is selling. How likely is it that I know something that this other person (or company) does not know?


• If I am selling, someone else is buying. How likely is it that I know something that this other person (or company) does not know?


• Have I calculated how much this investment needs to go up for me to break even after my taxes and costs of trading?

Next, look in the mirror to find out whether you are the kind of person who correctly anticipates your regret. Start by asking:

"Do I fully understand the consequences if my analysis turns out to be wrong?"



Answer that question by considering these points:

• If I am right, I could make a lot of money. But what if I'm wrong? Based on the historical performance of similar investments, how much could I lose?


• Do I have other investments that will tide me over if this decision turns out to be wrong? Do I already hold stocks, bonds, or funds with a proven record of going up when the kind of investment I'm considering goes down? Am I putting too much of my capital at risk with this new investment?


• When I tell myself, "You have a high tolerance for risk," how do I know? Have I ever lost a lot of money on an investment? How did it feel? Did I buy more, or did I bail out?


• Am I relying on my willpower alone to prevent me from panicking at the wrong time? Or have I controlled my own behaviour in advance by diversifying, signing an investment contract, and dollar-cost averaging?

You should always remember, in the words of the psychologist Paul Slovic, that "risk is brewed from an equal dose of two ingredients - probabilities and consequences."


Before you invest, you must ensure that you have realistically assessed your probability of being right and how you will react to the consequences of being wrong.





Ref: cc Intelligent Investor by Benjamin Graham

Know Yourself and Make More Money

Know Yourself and Make More Money
By Selena Maranjian
June 25, 2009





If you want to be a better investor, you have to know how your mind works. Not everyone thinks the same way about investing, and if you don't know your own particular quirks -- and weaknesses -- then it'll show in your results.

In particular, think about some of your not-so-wonderful investing habits. Even if they don't come to mind right away, odds are that you'll find a whole host of examples if you dig out some of your old brokerage statements and review some of your bone-headed investments. Try to figure out what led you to make those mistakes. Here are some possibilities:

Do you get swayed by an exciting detail or two? For instance, both Google (Nasdaq: GOOG) and Intuitive Surgical (Nasdaq: ISRG) have had amazing revenue growth in recent years, with average annual rates of 72% and 57%, respectively. But don't invest without filling out the picture much more. There's simply no way those growth rates are sustainable in the long run. In the current recession, demand for Intuitive's expensive robotic surgery equipment has slowed. Even companies that enter a slower-growth phase can make profitable investments, though, as Wal-Mart (NYSE: WMT) shareholders can attest.

Do you get too impatient? Did you maybe invest in Diamond Offshore (NYSE: DO) or Adobe Systems (Nasdaq: ADBE) a year ago, based partly on their robust margins, revenue growth, and return on equity? Are you thinking of selling them just because they're down over 30% in the past year? Well, next time you look at them and your trigger finger starts itching, be patient -- that's a key trait of great investors. As long as you remain confident of their strength and promise, holding can be the best thing to do.

Conversely, are you sometimes pigheaded? If you're holding on to companies just because they're down, even though you've lost faith in them, that's not such a good idea. Maybe, for example, you lost money on Capital One Financial (NYSE: COF) or Bank of America (NYSE: BAC), and are worried about new regulations in the credit card industry and the chance of increased loan defaults in the recession. If so, at least think about moving your money into a company you feel more confident about.

Do you focus much more on a stock's positives than its negatives? Are you eager to buy a stock after hearing someone on TV rave about it, without looking into his track record or the stock itself? If those traits haven't gotten you in trouble already, they certainly will in the future.


Discover your unproductive tendencies, so that you can notice and avoid them when they rear their ugly heads. Your portfolio might thank you for it.



http://www.fool.com/investing/general/2009/06/25/know-yourself-and-make-more-money.aspx





Learn more:
Mr. Market's 3 Biggest Weaknesses
4 Ways to Destroy Your Retirement
8 Common Investing Mistakes
Not-so-wonderful investing habits

Are You Taking Too Much (or Too Little) Risk?

Are You Taking Too Much (or Too Little) Risk?
by Christine Benz
Friday, February 27, 2009
provided by

Assessing a client's risk tolerance--an individual's own assessment of his or her ability to withstand investment losses--is standard practice in the financial-planning world. The Web is full of tools to help investors gauge how they would respond if the market dropped 10%, 20%, or even 50%, and I often hear from readers who tell me that their risk tolerance is "high" or "low."

The basic premise behind getting investors to identify their pain thresholds makes sense. After all, reams of data, including Morningstar Investor Returns, show that investors often buy high and sell low. By identifying their ability to handle losses and avoiding those investments that will cause them to sell at the wrong time, investors should be able to improve their overall return records.

Yet relying disproportionately on your risk tolerance to shape your investments carries its own big risk: namely, that you'll end up with a portfolio that doesn't help you reach your goals because you've been too aggressive or too timid. Instead, risk tolerance should take a back seat to the really important considerations, such as the size of your current nest egg, your savings rate, the years you have until retirement, and the number of years you expect to be retired. Only after you've developed a portfolio plan based on those factors should you consider making adjustments around the margins to suit your risk tolerance.


The Risk of Being Too Aggressive ...

Generally speaking, I'm happy to hear from investors who rate their risk tolerance as "high." These folks' long-term mind-sets allow them to tune out the market's inevitable day-to-day gyrations and weather big losses from time to time--characteristics that usually go hand in hand with profitable investing.

Yet being too aggressive isn't always a good thing. For one thing, it's possible that you're misreading your own risk tolerance and won't behave as you think you will if and when your investments lose money. Studies from the field of behavioral finance indicate that investors' confidence level--and in turn their perceived ability to handle risk--ebbs and flows with the market's direction. Thus, an investor might rate highly his own ability to handle risk at the very worst time--when the market is skyrocketing and stock valuations are high--only to exhibit much less confidence in the event of a market drop. (Not surprisingly, buoyant markets are also when most financial-services firms hawk the riskiest products.)

Moreover, being loss-averse has a foundation in simple math. After all, the stock that drops from $60 to $45 has lost 25% of its value, but it will have to gain 33% to get back to $60. The same cruel math holds for the whole of your portfolio, so it's no wonder that investors are inclined to rate themselves as risk-averse; losses are tough to recover from.

Big losses can be particularly painful for those who are getting close to retirement, because their portfolios have less time to recover from the hit. If you're 30 and your 401(k) balance goes down by 37%--as the S&P 500 did last year--it's a painful but not cataclysmic blow. After all, you might have 30 years or more to recoup those losses, and depressed stock valuations give you the opportunity to buy stocks on the cheap.

By contrast, if you're in your mid-60s and saw your retirement-plan balance shrink from $800,000 to little more than $500,000 over the past year, you don't have as many options. You could continue working to amass more savings or dramatically scale back your planned standard of living in retirement, neither of which is particularly appealing. The bottom line is that there are real reasons to grow more protective of your nest egg as you grow closer to needing your money, and there are real risks to letting your own assessment of your risk tolerance guide your asset-allocation decisions.

... Or Too Conservative

However, with the market dropping sharply over the past year, I'd wager that being too conservative is a bigger risk for many investors right now than is maintaining a portfolio that's too aggressive. Just as investor confidence improves as stocks march upward, so does pessimism take over when stocks are in the dumps.

Yet anyone tempted to make his portfolio more conservative should ponder a real risk of that tactic. By avoiding stocks and sticking exclusively with "safe," fixed-rate securities such as CDs or short-term Treasuries, you also put a cap on your portfolio's upside potential, which in turn heightens the risk of a shortfall come retirement. True, stocks have greater loss potential than do short-term fixed-income investments, but they also have the potential for greater gains. Moreover, the gains from short-term, high-quality investments are pretty darn skimpy right now: You're lucky to earn 3% on a one-year CD.

That might not sound terrible. After all, the S&P 500 Index has lost about 3%, on an annualized basis. Yet while inflation is currently minimal right now, it won't always be so benign. In fact, inflation has the potential to gobble up most, if not all, of the return you earn from any fixed-rate investment. The upshot? For retirees, pre-retirees, and 20-somethings alike, hunkering down in safe, fixed-rate investments is a luxury you probably can't afford, even if it helps you sleep at night. To help offset the effects of inflation, you need to have at least part of your portfolio in stocks, whose returns have the potential to outstrip inflation over time.

Just Right

So if it's a bad idea to let your gut guide your stock/bond mix, what should you do? Your key mission is to let hard numbers--rather than your own comfort level--be the chief determinant of your asset-allocation plan. Employ an online asset-allocation tool, such as Morningstar's Asset Allocator, to help you optimize your asset allocation based on your goals, your savings rate, and the number of years you have until retirement. Alternatively, you could hire a financial advisor for even more customized help or look to the asset allocations of target-maturity funds for back-of-the-envelope guidance. (David Kathman discussed how to do that in a recent The Short Answer column.)

Once you've put your basic asset-allocation framework in place, it's fine to make some adjustments around the margins based on your own comfort level. For example, if you determine that you should have the majority of assets in equities, you could focus on underpriced large-cap stocks or invest with a stock-fund manager who places a premium on limiting losses. On the bond side, you could limit your portfolio's risk level by going light on more-volatile asset classes like high-yield bonds and sticking with high-quality short- and intermediate-term bonds.

Beyond these small adjustments, it's a big mistake to let your emotions--and that's essentially what irrational risk aversion is--drive your portfolio planning. If the market's ups and downs leave you with excess nervous energy to burn, focus on factors you can actually influence, such as improving your security selection and lowering your overall investment-related and tax costs.

http://finance.yahoo.com/retirement/article/106656/Are-You-Taking-Too-Much-or-Too-Little-Risk;_ylt=AgJi2m23enNuwutOjND70J5O7sMF?

Don't Make These Three Investment Mistakes

Don't Make These Three Investment Mistakes
Christopher Davis
Tuesday December 9, 2008, 7:00 am EST


In the world of traditional economists and finance professors, though, that's not supposed to happen. If investors are rational decision-makers, then emotion-driven bubbles shouldn't be possible. Yet human weaknesses can limit our ability to think clearly. Many studies of investor behavior have shown that investors are:

• too willing to extrapolate recent trends far into the future,


• too confident in their abilities, and


• too quick (or not quick enough) to react to new information.

These tendencies often lead investors to make decisions that run counter to their own best interests.


The idea that investor psychology can result in poor investment decisions is a key insight of an increasingly influential field of study called behavioral finance. Behavioral-finance theorists blend finance and psychology to identify deep-seated human traits that get in the way of investment success. Behavioral finance isn't just an interesting academic diversion, however. Its findings can help you identify--and correct--behaviors that cost you money.


What commonplace mistakes should investors avoid? Here are a few key behavioral-finance lessons worth heeding.


Don't Read Too Much into the Recent Past



When faced with lots of information, most people come up with easy rules of thumb to help them cope. While useful in some situations, these shortcuts can lead to biases that cause investors to make bad decisions. One example is "extrapolation bias," the overreliance on the past to assess the future. Instead of doing all the necessary and possibly tedious homework in researching a potential investment, investors instead "anchor" their expectations for the future in the recent past.


The problem, of course, is that yesterday doesn't always tell you what tomorrow will bring. If you don't believe us, just ask investors who swarmed red-hot technology- and Internet-focused stocks in 1999 and 2000 expecting the good times to continue. They didn't, and most folks ended up suffering huge losses. Those who dove into real estate or natural-resources funds in more recent years are learning the same lesson now.


It's also worth pointing out that you can make the same mistake in the other direction. It's been a horrible year for the markets, but that won't last forever either. Just as it's a mistake to assume the good times will never end, it's also foolish to think in bad times that they'll never end.


Realize That You Don't Know As Much As You Think



In a 1981 study asking Swedish drivers to assess their own driving abilities, 90% rated themselves as above average. Statistically speaking, that's just not possible. But most of us are just like the Swedes: We think that we're more capable and smarter than we really are. As an investor, you should check your excessive optimism at the door. You might believe you're more likely than the next guy to spot the next Microsoft (NasdaqGS:MSFT - News), but the odds are you're not.


According to several studies, overconfident investors trade more rapidly because they think that they know more than the person on the other side of the trade. And all that trading can be hazardous to your wealth, as University of California, Berkeley professors Brad Barber and Terrance Odean put it in their 2000 study of investor trading behavior. The study looked at approximately 66,000 households using a discount broker between 1991 and 1996 and found that individuals who trade frequently (with monthly turnover above 8.8%) earned a net annualized return of 11.4% over that time, while inactive accounts netted 18.5%. Investors who traded most often paid the most in brokerage commissions, taking a huge bite out of returns.


All that trading might've been worthwhile if investors replaced the stocks they sold with something better. But interestingly, the study found that, excluding trading costs, newly acquired stocks actually slightly underperformed the stocks that were sold. That means that rapid traders' returns suffered whether or not fees were taken into account. Some researchers have come to a similar conclusion studying fund manager trading--standing pat is often the best strategy.


Keep Your Winners Longer and Dump Your Losers Sooner



Investors in Odean and Barber's study were much more likely to sell winners than losers. That's exactly what behavioral-finance theorists would predict. They've noticed that investors would rather accept smaller but certain gains than take their chances to make more money. On the flip side, investors are reluctant to admit defeat and sell stocks that are underwater in hopes of a rebound. As a result, investors tend to sell their winners too early and hang on to their losers for too long.


One way that investors can avoid leaving too much money on the table is to rebalance their portfolios less often. Rebalancing involves regularly trimming winners in favor of laggards. That's a prudent investing strategy because it keeps a portfolio diversified and reduces risk. But rebalancing too frequently could limit your upside. Instead, rebalance only when your portfolio is out of whack with your target allocations. Minor divergences from your targets aren't a big deal, but when your current allocations grow to more than 5 percentage points beyond your original plan, it's time to cut back. To learn more about rebalancing your portfolio, click here.


You also shouldn't be afraid to sell a loser because it will turn a paper loss into a real one. Hanging on to a dog in hopes of breaking even is a bad idea because you may be forgoing a better opportunity. The trick is knowing when it's time to cut bait. That's why it pays to have clear reasons in mind for your purchase of any investment right from the get-go. If your expectations don't pan out, then it's time to sell.

It's All about Discipline

Fortunately, you don't have to be a genius to be a successful investor. As Berkshire Hathaway chief and investor extraordinaire Warren Buffett said in a 1999 interview with Business Week, "Success in investing doesn't correlate with IQ once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing." It's true that not everyone is gifted with Buffett's calm, cool demeanor. But challenging yourself to avoid your own worst instincts will help you reach your financial goals.


Christopher Davis does not own shares in any of the securities mentioned above.



http://finance.yahoo.com/news/Dont-Make-These-Three-ms-13780451.html

5 Investing Statements That Make You Sound Stupid

5 Investing Statements That Make You Sound Stupid
by Amy Fontinelle

Some people love to talk stocks, and some people love to laugh at those people when they try to sound smart and important but they don't know what they're talking about. If you want to be a part of group No. 1 and avoid being the brunt of the jokes from group No. 2, you've come to the right place. This article will help you sound knowledgeable and wise while talking about the market. Here are five things you shouldn't say, why you shouldn't say them and what an experienced investor would have said instead.

Statement No. 1: "My investment in Company X is a sure thing.

"Misconception: If a company is hot, you'll definitely see great returns by investing in it.

Explanation: No investment is a sure thing. Any company can have serious problems that are hidden from investors. Many big-name companies - Enron, WorldCom, Adephia and Global Crossing, to name a few - have fallen. Even the most financially sound company with the best management could be struck by an uncontrollable disaster or a major change in the marketplace, such as a new competitor or a change in technology. Further, if you buy a stock when it's hot, it might be overvalued, which makes it harder to get a good return. To protect yourself from disaster, diversify your investments. This is particularly important if you choose to invest in individual stocks instead of or in addition to already-diversified mutual funds. To further improve your returns and reduce your risk when investing in individual stocks, learn how to identify companies that may not be glamorous, but that offer long-term value.(To learn about other "sure things" that went bad, read The Biggest Stock Scams of All Time.)

What an experienced investor would say: "I'm willing to bet that my investment in Company X will do great, but to be on the safe side I've only put 5% of my savings in it."


Statement No. 2: "I would never buy stocks now because the market is doing terribly."

Misconception: It's not a good idea to invest in something that is currently declining in price.

Explanation: If the stocks you're purchasing still have stable fundamentals, then their currently low prices are likely only a reflection of short-term investor fear. In this case, look at the stocks you're interested in as if they're on sale. Take advantage of their temporarily lower prices and buy up. But do your due diligence first to find out why a stock's price has been driven down. Make sure it's just market doldrums and not a more serious problem. Remember that the stock market is cyclical, and just because most people are panic selling doesn't mean you should, too. (To learn more read, What Are Fundamentals? and Buy When There's Blood In The Streets.)

What an experienced investor would say: "I'm getting great deals on stocks right now since the market is tanking. I'm going to love myself for this in a few years when things have turned around and stock prices have rebounded.


"Statement No. 3: "I just hired a great new broker, and I'm sure to beat the market."

Misconception: Actively managed investments do better than passively managed investments.

Explanation: Actively managed portfolios tend to underperform the market for several reasons. Here are three important ones:

1. Whenever you make a trade, you must pay a commission. Even most online discount brokerage companies charge a fee of at least $5 per trade, and that's with you doing the work yourself. If you've hired an actual broker to do the work for you, your fees will be significantly higher and may also include advisory fees. These fees add up over time, eating into your returns.
   
2. There is the risk that your broker might mismanage your portfolio. Brokers can pad their own pockets by engaging in excessive trading to increase commissions or choosing investments that aren't appropriate for your goals just to receive a company incentive or bonus. While this behavior is not ethical, it still happens.
   
3. The odds are slim that you can find a broker who can actually beat the market consistently if you don't have a few hundred thousand dollars to manage.

Instead of hiring a broker who, because of the way the business is structured, may make decisions that aren't in your best interests, hire a fee-only financial planner. These planners don't make any money off of your investment decisions; they only receive an hourly fee for their expert advice. (To learn more, Understanding Dishonest Broker Tactics and Words From The Wise On Active Management.)

What an experienced investor would say: "Now that I've hired a fee-only financial planner, my net worth will increase since I'll have an unbiased professional helping me make sound investment decisions."


Statement No. 4: "My investments are well-diversified because I own a mutual fund that tracks the S&P 500."

Misconception: Investing in a lot of stocks makes you well-diversified.

Explanation: This isn't a bad start - owning shares of 500 stocks is better than owning just a few stocks. However, to have a truly diversified portfolio, you'll want to branch out into other asset classes, like bonds, treasuries, money market funds, international stock mutual funds or exchange traded funds (ETF). Since the S&P 500 stocks are all large-cap stocks, you can diversify even further and potentially boost your overall returns by investing in a small-cap index fund or ETF. Owning a mutual fund that holds several stocks helps diversify the stock portion of a portfolio, but owning securities in several asset classes helps diversify the complete portfolio. (To get started, read Diversification Beyond Equities and Diversification: It's All About (Asset) Class.)

What an experienced investor would say: "I've diversified the stock component of my portfolio by buying an index fund that tracks the S&P 500, but that's just one component of my portfolio."


Statement No. 5: "I made $1,000 in the stock market today."

Misconception: You make money when your investments go up in value and you lose money when they go down.

Explanation: If your gain is only on paper, you haven't gained any money. Nothing is set in stone until you actually sell. That's yet another reason why you don't need to worry too much about cyclical declines in the stock market - if you hang onto your investments, there's a very good chance that they'll go up in value. And if you're a long-term investor, you'll have plenty of good opportunities over the years to sell at a profit. Better yet, if current tax law remains unchanged, you'll be taxed at a lower rate on the gains from your long-term investments, allowing you to keep more of your profit. Portfolio values fluctuate constantly but gains and losses are not realized until you act upon the fluctuations.

What an experienced investor would say: "The value of my portfolio went up $1,000 today - I guess it was a good day in the market, but it doesn't really affect me since I'm not selling anytime soon."


Conclusion

These misconceptions are so widespread that even your smartest friends and acquaintances are likely to reference at least one of them from time to time. They may even tell you you're wrong if you try to correct them. Of course, in the end, the most important thing when it comes to your investments isn't looking or sounding smart, but actually being smart. Avoid making the mistakes described in these five verbal blunders and you'll be on the right path to higher returns.

by Amy Fontinelle, (Contact Author Biography)

Amy Fontinelle earned her Bachelor of Arts degree from Washington University in St. Louis. In addition to writing for Investopedia, Amy also has her own personal finance website, Two Pennies Earned, which makes it easy and fun to save more, earn more and be financially secure both today and in the future. Amy is also a special contributing writer to the website Personal Finance Advice. When she's not writing, Amy enjoys photography, traveling and trying new restaurants. To learn more about Amy, please visit her personal site.

http://www.investopedia.com/articles/basics/08/investment-verbal-blunders.asp?partner=basics

Bargain Conundrum - another cognitive error

A stock has done tremendously well for a period of time. Investors tend to extrapolate linearly, assuming that a company which has done well in the last few years is expected to continue to do so.

Then came the correction. For many buyers, it was an opportunity to get in.

Here lies the bargain conundrum - another cognitive error that consistently lead us to make irrational decisions. The belief is that the price uptrend would resume. That this correction could be a reversal may not feature in the thinking or radar of most.

One risk in the investment world that is often overlooked is behavioural risk. Recognising such flaws which the field of behavioural finance has uncovered is the first step towards being more rational in one's investing.


Also read:
Evaluating Changing Fundamentals (Part 3 of 5)
· Don't automatically buy because a stock falls in price; re-evaluate as if new.
Ask ourselves:
Is the correction a true bargain?
Maybe the price uptrend would resume?
Or, maybe not, this being a reversal of the uptrend?
Obviously, having an idea of where the "fair value" of the stock is, helps.