Man does not need the mortar of
truth to seal up the prisons of his
fear.
Montaigne
From last week:
2. Have an Investment Plan; don’t react.
5. Diversify
7. You are your own worst enemy,
beware.
• Avoid market expert advice on when and
what to buy and sell
• Dare to be dull.
• Anticipation is better than the pleasure.
Page 98 in your text.
Fear and Greed
• Survey of 1,000 investors, 51% chance in any
given year, the U.S. stock market might drop
by 1/3.
• The odds are only around 2% that U.S. stocks
will lose 1/3 in a given year.
Fear and Greed
• 2003 in the U.S.:
• 24 people died on commercial aircraft
• 42,643 were killed in car accidents
• you’re about 65 times more likely to die in
your own car
• “risk aversion myopia”
2 for 1 sale
The Dow from 1929-2008:
• Daily rose 51.6% of days;
fell 48.4% of days
• Monthly rose 57.5% of months;
fell 42.5% of months
• Yearly
52 winning years
28 losing
not quite 2 to 1
Daniel Kahneman
“following their changes constantly is a very,
very, bad idea.
It’s the worst possible thing you can do,
because people are so sensitive to short-term
losses.
If you count your money every day, you’ll be
miserable.”
We are pattern seeking primates in a
world of randomness.
●■●●●■■●■■
After a single ■ or a single ●
after ■■
expected a third ■
after ●●
expected another ●
????
• A run of two of anything can cause your
investment brain to expect that three in a row
is coming.
• Once people conclude that an investment’s
returns are “predictable,” their brains respond
with alarm if that apparent pattern is broken.
Gambler’s fallacy
HTTHTH
HHHHHH
Gambler’s fallacy
HTTHTH
HHHHHH
one-in-64 chance or 1.6% of occurring
Gambler’s Fallacy
…because of a long string of losses in cards or
coin tossing that the next result has to go the
other way. NOT SO.
Random event producers have no memory.
Prices in the market are random in the short
run.
• Build a diversified portfolio and rebalance –
otherwise stay put
• Do not watch the market or the financial
news
We Are Overconfident
• 97% of drivers believed they were better than
the average driver!!!
• 750 of investors – 74% expected their mutual
funds to outperform the market every year
We Are Overconfident
…Ability to get along with others
• 100% ranked themselves in the top half of the
population
• 25% believed they were in the top 1 percent
of the population.
WE DO NOT LIVE IN LAKE WOBEGONE!
Page 125 is worth more than you
paid for this book. If you don’t
want to be poor, memorize this
page and LIVE it!
Pride and Regret
• “Financial decision-making is not necessarily
about money. It’s also about intangible
motives like avoiding regret or achieving
pride.”
Daniel Kahneman,
Psychologist
Princeton University
Familiarity breeds…
• The eerie power of Mere Exposure
• “EXPOSURE EFFECT”
• Robert Zajonc (“zye-ontz”)
“EXPOSURE EFFECT”
• Most retirement investment is in the stock of
the workers’ employer.
• The stocks with the highest trading volume
get the most attention.
• Stocks with the most familiar names turn up
as the most actively traded, and
• Underperform the market by 2 to 5%.
Regret
“I visualized my grief if the stock market went
way up and I wasn’t in it – or if it went way
down and I was completely in it…”
“…50/50 between bonds and equities.”
Harry M. Markowitz
“Portfolio Selection” for the Journal of Finance
Breaking Up Is Hard To Do
…when investors are racked with regret?
Most people don’t panic;
…instead, they freeze.
Regret
• Bob owns stock A. Considered switching to
stock B, but didn’t. His inaction cost him a
$2,500, he would have gained from a switch.
• Mary owns stock B. She switches to stock A
and finds she would have been better off by
$2,500 if she had done nothing.
Regret
• Bob owns stock A. Considered switching to
stock B, but didn’t. His inaction cost him a
$2,500, he would have gained from a switch.
• Mary owns stock B. She switches to stock A
and finds she would have been better off by
$2,500 if she had done nothing.
• 92% says Mary feels more regret
• A mistake from action feels worse than a
mistake from inaction.
Everyone has regrets
• Remember that losses garner more regret
than a foregone gain.
• Even when the result is financially the same.
The Psychological time value of money
• Would you rather get $10 today, or $11
tomorrow?
The Psychological time value of money
• Would you rather get $10 a year from now, or
$11 a year and a day from now?
The Psychological time value of money
• Would you rather get $10 today, or $11
tomorrow?
• Would you rather get $10 a year from now, or
$11 a year and a day from now?
The Psychological time value of money
• If you are like most people, you would rather
get $10 today than wait 24 hours for an extra
dollar.
• Although the two rewards are separated by an
identical 24 hour delay, most people now
change their answer to $11 in the second
case!
The Psychological time value of money
• It seems easier to be patient in the future
than in the present.
Two Minds About Time
Ant or Grasshopper???
The Psychological time value of money
• 401(k) rollovers - Fewer than half
• Credit Cards - three out of four accounts incur
monthly interest charges!
• Taking Social Security at age 62, monthly
benefits will be only 75%
Yet 70% of retirees choose to take their
benefits before full retirement age.
The Psychological time value of money
• This explains why most people prefer $10 today over
$11 tomorrow but would wait for the extra dollar a
year from now.
• Because gains and losses have so much emotional
power in the present, but fade when they are
delayed into the future, we suffer chronic confusion
between the price of buying something and the cost
of owning it.
Next Week’s Key Points
• Pages 127-142
• 8. Costs Kill
• Beware of Full Commission brokers and Most
Equity Mutual Funds (Refer to pages 56-67)
• Next week I will explain why I agree and
disagree with our author’s cynicism.
“You must not fool yourself – and you are the
easiest person to fool”
Richard Feynman
“You must not fool yourself – and you are the
easiest person to fool”
Richard Feynman