Mindful Investing
Avoiding common investment mistakes
Mindful investing
“state of
shocked disbelief”
Mindful investing
Agenda for today
• Investor behaviour
• Mental shortcuts
• Predictable cognitive mistakes
• Investor emotions
• Financial leadership remedies
Investor behaviour
Equity fund investor vs. S&P 500 Index
20.00%
10.00%
2008
1.87%
8.35%
S&P 500
0.00%
20 Years
1989 - 2008
-10.00%
-20.00%
-30.00%
-40.00%
- 41.63%
- 37.72%
-50.00%
Source: Dalbar, Quantitative Analysis of Investor Behaviour, 2009.
Equity fund
investor
Investor behaviour
Equity fund investor vs. S&P 500 Index from 1989-2008
$500,000
$450,000
$400,000
$350,000
$316,739
$300,000
$458,933
$250,000
at 8.35%
$200,000
$150,000
$100,000
$100,000
$142,194
$50,000
at 1.87%
$0
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
S&P 500
Source: Dalbar, Quantitative Analysis of Investor Behaviour, 2009.
Equity fund investor
Investor behaviour
Bogle says investors are getting killed in ETFs
25.0%
15.6%
15.0%
3.8%
5.0%
-5.0%
6.0%
-1.8%
ETF
return
-1.7%
-2.2%
-7.7%
-10.5%
-12.0%
-15.0%
-25.0%
-28.6%
-35.0%
Large-Cap
Value
Large-Cap
Growth
Emerging
Markets
Financials
All ETFs
Source: Matt Hougan, IndexUniverse.com, Bogle: Investors Are Getting Killed In ETFs, Wednesday, 17 June 2009.
Investor
return
Investor behaviour
Value of advice
• Investment returns more dependent on investor behaviour than
on fund performance
Investment
Return
Investor
Behaviour
Investor
Return
Source: Carl Richards, Behavior Gap: The Psychology of Investing, Copyright 1999-2010 by GetRichSlowly.org
Investor behaviour
Original assumptions
Assumption #1:
Markets are efficient
Assumption #2:
Investors are rational
Investor behaviour
Behavioural finance – investors are…
• not “rational”
• “normal”
• predictably normal
Investor behaviour
Predictably normal
• Certain mistakes are systemic
• We repeat them again and again
• We can learn to recognize and understand them
• Incorporate into our thinking
• Account for them in our decisions
• Adjust for them in our expectations
Mental shortcuts
• Optical illusions
• Predictable cognitive mistakes
Source: Mindvestor, 2009.
Optical illusions
Which black dot looks bigger?
Optical illusions
Which line looks longer?
Optical illusions
Which table looks longer?
Predictable cognitive mistakes
Asymmetric loss aversion
Herding and pattern seeking
Overconfidence
Availability bias
Asymmetric loss aversion
Coin toss
• Heads – you pay me $100
• Tails – I pay you $X
How much would I have to pay you?
$200 - $300
Asymmetric loss aversion
How do investors perceive losses?
Investment Value (000s)
110
100
90
80
70
60
50
40
30
20
10
Fund A
Fund B
Asymmetric loss aversion
Symptoms of loss aversion
• Taking money out of the stock market when prices
fall1
• You tend to sell winning investments more readily
than losing investments1
• Choosing only GICs or bonds and avoiding stocks1
• Leaving money sitting in cash and not wanting to
invest it – even when the market stabilizes
Source: 1Belsky, Gary, and Thomas Gilovich. Why smart people make big money mistakes and how to correct them: lessons
from the life-changing science of behavioral economics. New York: Simon & Schuster, 2009. pg. 65. Print.
Asymmetric loss aversion
Remedies for loss aversion
• Discuss this normal behaviour with your clients
• Focus on long-term performance and not short-term
volatility
• Create a comprehensive financial plan that is based
on a portfolio of diversified investments – not one
stock
• Develop – and stick to – an Investment Policy
Statement
Herding and pattern seeking
Herding and pattern seeking
Solomon Asch experiment
• 7 to 9 college students
• All but 1 were confederates
• The lone man was told the experiment dealt with
visual judgment
Source: Asch, Solomon E., “Effects of group pressure upon the modification and Distortion of judgment," in h. Guertzkow, ed.,
Groups, leadership, and men (Pittsburgh, PA: Carnegie press, 1951).
Herding and pattern seeking
Solomon Asch experiment
Source: Asch, Solomon E., “Effects of group pressure upon the modification and Distortion of judgment," in h. Guertzkow, ed.,
Groups, leadership, and men (Pittsburgh, PA: Carnegie press, 1951).
Herding and pattern seeking
Solomon Asch experiment
• 75% yielded to majority on at least 1 trial
• 50% yielded to majority on over half the trials
• 25% never conformed
In 37% of trials,
the “lone man” yielded to the majority.
Source: Asch, Solomon E., “Effects of group pressure upon the modification and Distortion of judgment," in h. Guertzkow, ed.,
Groups, leadership, and men (Pittsburgh, PA: Carnegie press, 1951).
Herding and pattern seeking
Follow the herd, then do the opposite
16000
$10.0
Aug. 08
13771.25
$8.0
14000
$6.0
Oct. 08
9762.76
12000
$2.0
10000
$0
-$2.0
8000
-$4.0
6000
Oct. 08
-$5,936,149
-$6.0
4000
-$8.0
Jan-06
Source: IFIC
Jan-07
Jan-08
S&P/TSX Composite Index
Jan-09
Feb-10
Long-term funds total net sales
Index
$ billions
$4.0
Herding and pattern seeking
Symptoms of herding and pattern seeking
• Spending decisions are heavily influenced by
products, restaurants or vacations spots that are “in”1
• Making investment decisions frequently1
• Investing in hot stocks/funds because they’re
“popular” and selling them when they’re “out of
favour” 1
• Basing investment decisions solely on the opinions of
others not on sound investment advice from a
knowledgeable advisor
Source: 1Belsky, Gary, and Thomas Gilovich. Why smart people make big money mistakes and how to correct them: lessons
from the life-changing science of behavioral economics. New York: Simon & Schuster, 2009. pg. 202. Print.
Herding and pattern seeking
Remedies for herding and pattern seeking
• Discuss this normal behaviour with your clients
• Be patient – don’t rush into investments
• Avoid hot stocks/funds and investment trends
• Turn down or tune out the noise – assess gains and
losses less frequently
• Create your own “rules”
• Look for opportunities to be a contrarian
Availability bias
Availability bias and overreaction
• “Mental availability”
• Predict - or react to - an event based on how easily
an example comes to mind
• Recent
• Relevant
• Dramatic
• Overreaction towards “available” information
Availability bias – dramatic
Availability bias – media impact
.02 Cancer Headlines per 1,000 Cancer Deaths
1.7 Murder Headlines per 1,000 Homicides
2.3 AIDS Headlines per 1,000 AIDS Deaths
138.2 Plane Crash Headlines per 1,000 Airplane Deaths
Source: Barnett, Dr. Arnold, “How numbers can trick you; the six deadly sins of statistical misrepresentation”,
Massachusetts Institute of Technology, Technology Review, October 1994, pg 39-45.
Availability bias
Symptoms of availability bias
• Choosing mutual funds that are heavily advertised or
stocks of companies that are frequently in the news1
• Overreacting to good/bad news
• Believing an “opinion” to be factual
Source: 1Belsky, Gary, and Thomas Gilovich. Why smart people make big money mistakes and how to correct them: lessons
from the life-changing science of behavioral economics. New York: Simon & Schuster, 2009. pg. 201. Print.
Availability bias
Remedies for availability bias
• Discuss this normal behaviour with your clients
• Avoid impulsive decisions based on an emotional
reaction – evaluate decisions based on a long-term
financial plan
• Access information that is free of cognitive biases –
usually through an advisor
• Remove sources that have a biased opinion
• Forget about your brother in-law!
Overconfidence
Overconfidence
• 82% of people say they are in the top 30% of drivers
Source: Tilson, Whitney, Applying Behavioural Finance to Value Investing, T2 Partners Inc., November 2005
Overconfidence
• 82% of people say they are in the top 30% of
drivers
• 80% of students think they will finish in the top half
of their class
• Business conference attendees retirement
estimates 2:1
• 86% MBA classmates say they are better looking
than their classmates
Source: Tilson, Whitney, Applying Behavioural Finance to Value Investing, T2 Partners Inc., November 2005
Overconfidence
Are investors overconfident?
7.9%
8.1%
11.8%
18.1%
…is what investors expect to earn in a typical year1
…is what investors expected to earn in 20022
…is what investors expected to earn in 20012
…is what investors expected to earn in 20002
Source: 1The Gandalf Group, Fall 2009 Canadian Investors’ Survey, Conducted on behalf of Standard Life, BNN and CTV,
November 2, 2009. 2Rheault, Magali. The Kiplinger Monitor, a change in attitude. April 1, 2002. 3Dalbar, Quantitative Analysis of
Investor Behaviour, 2009.
Overconfidence
Are investors overconfident?
7.9%
6.8%
9.9%
-1.57%
…is what investors expect to earn in a typical year1
…rolling 3-year average S&P 500 total return 1999-2008
…rolling 3-year average S&P/TSX total return 1999-2008
…equity investor return 1999-20083
Source: 1The Gandalf Group, Fall 2009 Canadian Investors’ Survey, Conducted on behalf of Standard Life, BNN and CTV,
November 2, 2009. 2Rheault, Magali. The Kiplinger Monitor, a change in attitude. April 1, 2002. 3Dalbar, Quantitative Analysis of
Investor Behaviour, 2009.
Overconfidence
Symptoms of overconfidence
• Are you human?
• Believing you can consistently “beat the market”1
• Making frequent trades – especially with a discount
or on-line brokerage1
• Not knowing your personal rate of return1
• Believing that “investing in what you know” is a
guarantee of success1
Source: 1Belsky, Gary, and Thomas Gilovich. Why smart people make big money mistakes and how to correct them: lessons
from the life-changing science of behavioral economics. New York: Simon & Schuster, 2009. pg. 177. Print.
Overconfidence
Remedies for overconfidence
• Discuss this normal behaviour with your clients
• Ask “three questions”
• Find an opinion contrary to yours – and think about it
• Write down the reasons you could be wrong (list of
pros and cons)
• Estimate a range of possible outcomes (i.e. portfolio
returns) then subtract 25% from the low number
Mindful investing
What we know:
#1
Investors suffer from
predictable cognitive mistakes
#2
They won’t go away
and we can’t ignore them
#3
We can learn to recognize
and understand them
Mindful investing
Emotions
Mindful investing
The cycle of market emotions
Point of maximum
financial risk
“Wow, I feel
great about this
investment.”
“Temporary setback.
I’m a long-term investor.”
Euphoria
Anxiety
Thrill
Denial
Excitement
Fear
Optimism
Point of maximum
financial opportunity
Desperation
Optimism
Panic
Relief
Capitulation
Despondency
“Maybe the markets
just aren’t for me.”
Source: Westcore Funds/Denver Investment Advisers LLC, 1998.
Hope
Depression
Mindful investing
Value of advice Financial
Leadership
Emotional maturity
Access to resources
unavailable to the
average investor
Depth of expertise
Tailored advice
Disciplined process
Objective
balanced perspective
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