By: Philip H. Weiss, CFA, CPA http://www.apprisewealth.com - - PowerPoint PPT Presentation
By: Philip H. Weiss, CFA, CPA http://www.apprisewealth.com philweiss@apprisewealth.com The Pathway to an Informed Retirement How often Maintain What if I have How do I stay should we B questions? on course? talk? Plan Updates Open Door
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The Pathway to an Informed Retirement
A relatively new field that seeks to combine behavioral and cognitive psychological theory with conventional economics and finance to provide explanations for why people make irrational financial decisions.
– Seth Klarman
“A large body of research suggests that investors profit most when they do the least.” Daniel Crosby
Carl Richards: Why Investor Behavior Needs to Change
to search for information proving what we already believe. We try to support, rather than refute,
look for evidence supporting our reasons for buying it (our investment thesis). We look to confirm that we are right.
found that people spend 36% more time reading an essay if it aligns with their opinions.
view
investment industry obsesses with trying to guess the future. Don’t
James Montier
have no idea and neither does anyone else,” but estimates like that don’t provide lobster lunches and fail to meet our need for a belief in a knowable future.
say, “I don’t know.”
“A remarkable aspect of your mental life is that you are rarely stumped … The normal state of your mind is that you have intuitive feelings and opinions about almost everything that comes your
before you know much about them; you trust or distrust strangers without knowing why; you feel that an enterprise is bound to succeed without analyzing it.” – Thinking Fast & Slow, page 97
completely failed to predict any of the last four recessions (even once we were in them).
motion picture, the head of Warner Brothers, said “Who the hell wants to hear actors talk?”
IBM, said “I think there is a world market for maybe five computers.“
capacity of the first-generation floppy disk, claimed that “640 kilobytes ought to be enough for anyone.”
predictive power in areas as diverse as Hollywood blockbusters, sporting
Averaged economic indicators are also greatly improved over the judgment of the typical estimate. What’s more, this effect is seen relatively quickly, with as few as 8 to 12 estimates providing results nearly as robust as much larger samples.
Daniel Kahneman
– System 1 – Impulsive – Automatic – Intuitive – Emotional
– Calculates – Considers Thoughts – Deliberate – Logical
water in 6 days, and Mary can drink one barrel of water in 12 days, how long would it take them to drink one barrel of water together?
the stock market one day early in
the stocks he purchased were down 50%. However, by October 17, the stocks he purchased rose 75%. At this point, Simon has
doubles in size. It takes 48 days for the patch to cover the entire lake, how long would it take for the patch to cover half the lake?
by without asking for help from System 2, it will do just
for help takes more energy.
would result in harm or injury:
http://www.mirror.co.uk/news/uk- news/heroic-rail-worker-risks-life- 9084822
confident in our opinions.
direct purview.
consider only the information that is directly at hand.
evaluating any message – the story and the source of the story. The story itself triggers the automatic thinking (“System 1 thinking”) and is the easiest and most immediate means by which we make a
requires much more time, attention, and intellectual horsepower, and therefore may not receive adequate attention.
Slow, “System 1 is radically insensitive to both the quality and the quantity of the information that gives rise to impressions and intuitions.”
investment? It has performed well in the past and has shown strong growth…”
the affirmative
be important qualities in a good stock, and “this is the best story that can be constructed from the two adjectives.
I need to know before reaching an informed
perform well in the future.”
results due to erroneous biases or prejudices
broad conclusions on entire groups (or “populations”)
ability to make correct predictions by using a group’s “base rate”
thought
tired) – Frequent breaks – Media fasting – Reading quietly
Heuristics: Simple, efficient rules which people often use to form judgments and make decisions. They are mental shortcuts that usually involve focusing on one aspect of a complex problem and ignoring others.
majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti- nuclear demonstrations.
– Which is more probable? – Linda is a bank teller. – Linda is a bank teller and is active in the feminist movement.
A formal fallacy (also known as the Linda problem) that occurs when it is assumed that specific conditions are more probable than a single general one.
A theory used in finance suggesting that asset prices and historical returns eventually return back to the long-run mean or average level of the entire data set.
Punishment vs. Praise
when they do well and punish them when they do badly, and because there is regression to the mean, it is part of the human condition that we are statistically punished for rewarding others and rewarded for punishing them.”
Project
deliver predictions that are too extreme, and you will be inclined to put too much faith in them.
– Julie is currently a senior in state university. She read fluently when she was four years old. What is her GPA?
less certain.
thing.
thinking.
processes for taking advantage of the worst markets before they come.
differently next time, but we probably won’t.
lead to:
– Inability to assess performance – Failure
process, we still have to control our emotions
“We have no control over outcomes, but we can control the
attention on process, we maximize our chances of good
Good Outcome Bad Outcome Good Process Deserved Success Bad Break Bad Process Dumb Luck Poetic Justice
One of the most important rules of behavioral investing is that results matter less than the process; you can be right and still be a
avoiding losses to acquiring equivalent gains: It is better to not lose $5 than to find $5. Some studies have suggested that losses are twice as powerful, psychologically, as gains.
stuff happening to you.
– A) Sure gain of $240. – B) 25% chance to gain $1,000 and 75% chance to gain nothing.
– Sure loss of $750. – 75% chance to lose $1,000 and 25% chance to lose nothing.
– 25% chance to win $240 and 75% chance to lose $760. – 25% chance to win $250 and 75% chance to lose $750.
Consider the Following:
b) An 80% chance of receiving $4000, but a 20% chance of receiving nothing.
preferred over the potential to win more but possibly get nothing. However, when given a very similar choice:
b) An 80% chance of losing $4000, but a 20% chance of losing nothing.
losing more for the chance to lose nothing. We are not logical. We struggle to evaluate risks and threats.
instead?
A behavioral economic theory that assumes losses and gains are valued differently, and thus individuals make decisions based on perceived gains instead of losses... The paper "Prospect Theory: An Analysis of Decision under Risk" (1979) has been called a "seminal paper in behavioral economics."
differently, and as such, will base decisions on perceived gains rather than perceived losses. Thus, if a person were given two equal choices, one expressed in terms of possible gains and the other in possible losses, people would choose the former.
alternatives, people avoid losses and
Describes cases in which a person uses a specific target number or value as a starting point, known as an anchor, and subsequently adjusts that information until an acceptable value is reached over time.
death using an anchoring question
pay for a house (what’s the asking price)
cost?
high or low price?
to its industry’s P/E
A cognitive error whereby too little weight is placed on the base (original) rate of possibility (e.g., the probability of A given B); i.e., we tend to ignore prior probabilities and focus on expected similarities.
Happens when: 1. There is a low base rate
2. We have a test for that condition. 3. Someone tests positive. 4. We assume that means they have the condition, ignoring the unreliability
with low base rates.
– Events that are representative or typical of a class are assigned a high probability of
– This heuristic is used when people judge the probability that an object or event A belongs to a class or process B.
– You are given a description of an individual and are required to estimate the probability that he/she has a certain occupation. – Estimate will be influenced by the similarity between the individual's description and your stereotype of that occupation.
mutual fund, which beat the S&P 500 10 years in a row. She majored in math at Harvard and received her MBA in Finance at Columbia both with high distinction. This indicates it is better to invest in the Alpha mutual fund rather than the S&P 500. True or False?
(1 in 1,024).
with “r” or that have “r” as their third letter?
the African elephant?”
Occurs when we evaluate information based on recent results or on our perspective
incorrect conclusions that ultimately lead to incorrect decisions.
The hypothesis that people ascribe more value to things merely because they own them.
The tendency to generalize from small amounts of data. About 50% of all babies are boys. In the larger hospital about 75 babies are born each day, and in the smaller hospital about 15 babies are born each
percentage of boys?
Also known as the knew-it-all-along effect or creeping determinism: The inclination, after an event has occurred, to see the event as having been predictable, despite there having been little or no objective basis for predicting it.
The Misconception: You make rational decisions based on the future value of
The Truth: Your decisions are tainted by the emotional investments you accumulate, and the more you invest in something the harder it becomes to abandon it.
separate their money into separate accounts based on a variety of subjective criteria, like the source of the money and intent for each account.
people are apt to save money labeled as a rebate but to spend money labeled as a bonus.
architecture that alters people’s behavior in a predictable way without forbidding any options or significantly changing their economic incentives.
processes and structures might lead to better choices.
anything, yet effectively promote good choices.
people, almost all the time, make choices that are in their best interest or at the very least are better than the choices that would be made by someone else.
more than 90% of eligible workers being enrolled.
nudged by other Humans. Why? One reason: we like to conform.
transparent and never misleading.
to opt out of the nudge, preferably with as little as one mouse click.
believe the behavior being encouraged will improve the welfare of those being nudged.
iNcentives Understand Mappings Defaults Give Feedback Expect Error Structure Simple Choices
company-sponsored 401(k) plans vs. opt in
eventually
“Would you like to be an
– Asking this question doubled the number of program participants in Illinois
and the calories you burn when you’re
can go into overdrive and wear you out.
from a person high on cocaine or morphine.
area of the brain that responds to mortal danger.
expects a third repetition after seeing 2 in- a-row.
larger response than actually receiving the gain.
you feel (regardless of how poor the odds might be).
receive. – If you receive an invite, you feel an
– You are more likely to say yes to those that you owe.
People want more of those things there are less of.
consistent with the things they have said and done before.
someone they know or like as a person. – We like people who are similar to us – We like people who give us compliments – We like people who cooperate with us
disco
https://youtu.be/cFdCzN7RYbw
We can all fall subject to behavioral biases. What can we do about it?
elements of both luck and skill.
assumptions around base rates/long-term averages. Not stories.
catastrophic events.
unless you feel self-doubt or hurt.
the default option 82%
system/eliminate discretion.
Consider rules to help you avoid catastrophic losses.
– Data must support your assertion.
to correlate with outsized returns, it probably doesn’t.
– Have a sound theory
– There should be an enduring psychological element.
how sound a strategy is. – A market beating three-year track record (the minimum hurdle for most institutional investors) still has a 12.5% chance of being total luck. It takes nearly 25 years of track record to separate luck from skill, meaning that you can only know via results that a manager was good as she is nearing
results makes our focus on theory, data, and psychology even more relevant.
market is nearly 13% from 1950 to present. The longer your horizon, the more likely you are to get the right result for the right reason. Behavioral investing must be long-term to be effective.
term survival to become a long- term investor is a bit like trying to paint a room with a hammer. You can do it, but it’s not pretty.
A Behaviorally Informed Portfolio/Running an Insurance Company
externalities by screening out the infirm.
shrewd investor both diversify.
– Studies suggest our ability to control
are limited, and we are more or less wired for immediacy. Our brains are primed for action, which is great news if you are in a war and awful news if you are an investor, fighting to save for your retirement.
– Perfect planning and preparation prevent piss poor performance – Do your investment research when in a cold, rational state – and when nothing is happening in the markets –and then pre-commit to following
action steps.
themselves to understanding the nature of the business and its intrinsic worth, rather than wasting their time trying to guess the unknowable future.
and backing out what it implies for future growth.
“Closely following daily fluctuations is a losing proposition, because the pain of frequent small losses exceeds the pleasure of frequent small gains…in addition to improving the emotional quality of life, the deliberate avoidance of exposure to short-term outcomes improves the quality of both decisions and outcomes. The typical reaction to bad news is increased loss aversion. Investors who get aggregated feedback receive such news much less often and are likely to be less risk averse and end up richer.” (p. 339) Which of the following most closely describes your investment
I want to build my wealth considerably; i.e., multiply my investment over the long run. For this I am willing to accept greater fluctuations (over 20%) in the value of my investment.
I want to build my wealth moderately and expect returns above regular interest rates. For this I am willing to accept fluctuations in my portfolio value of around 10-20%.
I want to maintain my wealth and protect against inflation. For this, I am willing to bear single-digit fluctuations in the performance of my portfolio.
I want a secure return on my investment with no potential for losses, not even if they are only short term.
than looking for an informational advantage that will guarantee a sure thing.
investment.
argument.
System 2.
(availability).
thesis. – What if you turned some of these assumptions on their head? – What if an upstart competitor threatens your company’s brand? – What if a trade war potentially jeopardizes the economy?
you arrive at an anti-thesis with a new accompanying price target.
a psychic phenomenon. Taking financial risk causes real bodily
extinguish since the body stores it for a rainy day. Bad news in the stock market is more regular than your birthday.
parlance, “thinking fast” leads us to rely on heuristics, biases and shortcuts, whereas the more effortful “thinking slow” leads us to consider decisions in their full contextual splendor.
simplification, emotion in and around financial markets is often lumped into one of two categories: fear or greed. Meditation, it would seem, is well positioned to tame both.
decision making, better memory formation, retention, and recall; greater creativity, greater focus; and better multidimensional thinking.
“style drift”).
just 2% to 3% of total body weight, it consumes as much as 25% of the body’s energy, even when we are at rest. As a result
brains are constantly searching for ways to go into energy saver mode and not work quite so hard.
and is 150,000 years old. It is much older than the markets (400 years old) it seeks to
2% to 3% of your body weight but consumes 25% of your energy. Humans are wired to act; markets tend to reward inaction. The importance of money seems to diminish, not improve, decision- making.
2) under actual conditions; and 3) in reaction to financial risk/reward stimuli.
Once we begin trading stocks, our brains begin to undergo subtle physical change that we can actually see in the MRIs of Traders…
thwart catastrophic losses, some investors have turned to momentum-based models. The most commonly used of these is some variant of a 200-day moving average, where an asset class is held as long as it is above the 200-day average of its price and sold when it dips below.
Faber measured the ten-month average at the end of the last trading day of each month. He bought when the monthly price was above the ten-month SMA and sold and moved to cash when the monthly price was below that level. The results were dramatic. From 1901 to 2012, this timing model returned 10.18% per year as opposed to 9.32% for the S & P 500 (>2x).
Newton’s first law of motion: every object in a state of uniform motion tends to remain in that state of motion.
histories of providing attractive returns, have performed well across markets and across asset classes, and have persisted for decades after their discoveries. Importantly, the two strategies perform even better when combined.” – Cliff Asness
independently and in concert, precisely because they exhibit the three hallmarks of an investable factor: empirical evidence, theoretical soundness and a behavioral foundation.” – Daniel Crosby
portfolio manager and one-part clinical psychologist
anticipating how they’re going to react to various market
to help each client understand what is possible and what isn’t.
markets are volatile, guidance from a behavioral coach can save us from panic selling and abandoning long- term financial plans.”
financial planning decisions can generate 29% more income on average for a retiree.”
findings suggesting that behavioral coaching is the single most impactful service an advisor can
education here.
the single most impactful thing an advisor can do, adding, on average 150 basis points.”
about psychology, behavior, and temperament than IQ or education. The ability to keep your cool and not go on a selling rampage during market downturns will serve you well.” – Millennial Investment World
discipline, and patience. No matter how great the talent or effort, some things just take time: You can’t produce a baby in one month by getting nine women pregnant.” – Warren Buffett
and stick to it?
a down market and/or keep from enthusiastically buying in a rising market?
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