5 Ways your brain tricks you into bad investment decisions.

Ways Your Brain Tricks You 5 INTO BAD INVESTMENT DECISIONS A Few Facts About the Stock Market YOUR CHANCES OF SUCCESS ARE GRIM! "The results [of the performance of wealth advisers over an eight year period] resembled what you would expect from a dice-rolling contest, not a game of skill."-Daniel Kahneman, winner of the 2001 Nobel Prize in economic sciences BUT IT IS NOT ALL LUCK FOR SOME Warren Buffett: Benjamin Graham: Average annual returns 13% better than the 21% annual returns over 20 years market (1976 – 2011) Sir John Templeton: Peter lynch: Quadrupled his investment in 4 years when Hitler invaded 29% average annual returns between 1978 and Poland 1990. Beat the market 11 out of 13 years running Magellan fund Turns out, most of us are not wired to make smart investment decisions THE STOCK MARKET IS COMPOSED OF RISK-TAKERS RISKS RISKS 50: Risk-taking is genetic: Carriers of the risk-averse Men and Women are 20-50% younger individuals more inclined to take risks The age at which risk-taking behavior peaks before beginning a decline gene take less likely to take risks at any age level 28% FEWER RISKS 51 Thinks the future is more unpredictable than it really is SHORT TERM VS LONG TERM INVESTMENTS COMPANIES FOCUS ON SHORT TERM results to reach quarterly numbers IGNORE long term positives Slight tumble occurs Investors pull out- STOCK DROPS Investors often want IMMEDIATE RESULTS Example: IN 2011, concerns over the Fiscal Cliff and the European debt caused investors to pull out nearly $115 billion in stock funds. In the end, the market rallied to a 16% total return, even when all signs pointed to an improving economy 41 Makes you want to protect your bad choices Loss Aversion: The tendency to strongly prefer avoiding losses to acquiring gains $200 V The psychological impact of LOSING $1 is 2.5 - 7 times greater Introduced in 1979 by Daniel Kahneman and Amos Tversky who worked under the assumption that the prospect of losing money has a larger impact on decision making than the prospect of making money. If faced with a 50% chance of winning $200 and a 50% chance of avoiding losing $100, most investors will always lean toward avoi- ding a $100 los. than the psychological impact of WINNING $1 31 You end up throwing good money after bad SUNK COST DILEMMA: The dilemma investors find themselves in when they have to decide between uncertain success over SUNK COST FALLACY: The notion that a company or individual will continue to sink money into a failing investment due to the amount of time and money already invested. certain loss. THE PRICE PAID for an investment should have no bearing on whether or not you should buy or sell 22 This results in: SALE Selling a stock prematurely, and Hanging onto or buying more of a losing stock, known as "catching a falling knife." THE NUMBER of milliseconds it takes for the cerebral cortex, the part of the brain concerned with decision making and reaso- ning, to receive news of risky information. Both practices can negatively impact your poryfolio 21 You confuse cheap and good value NEVER BUY BECAUSE SOMETHING LOOKS CHEAP. Kodak BERKSHIRE HATHAWAY INC. Low share price does not always = GOOD'DEAL Eastman Kodak: $0.20/share, but bleak future prospects Berkshire Hathaway: >$145,000/share, but excellent future prospects Always based on current and future prospects You think just because everyone you know is doing it, it must be the right thing to do HERD MENTALITY: BECAUSE EVERYONE ELSE IS DOING IT, YOU MUST AS VWELL Forces investors to miss out on the Prevents you from getting out before the market hits the top or when you sense danger bottom floor of booming markets • Very few bought stock in now big-name companies such as Apple, causing others to follow suit. The end result was missing out on what turned out to be one of the greatest investments ever • Emotions, not logic, rule decision making in the stock market CNBC proclaiming Bear Stearns is fine "Do not move your money out of Bear" on Mar 11, 2008 > Often perpetuated by the financial media > 6 days later, Bear Stearns stock dropped 90% and needed a Federal bailout Source: Youtube video: http://www.youtube.com/wat- ch?v=HPc16cuQJRO > Business Week, August 13th, 1979: Predicted the "death of equities." Result: Multi-decade bull market DUTCH TULIP MANIA After the introduction of tulips to the Dutch in 1593, their relative rarity and novelty, in part due to a virus that caused their colors to change, resulted in a huge spike in price, prompting investors to trading land and life savings to acqui- re them. After the virus spread, the price came crashing down, resulting in many people losing their livelihoods for a flower. Want a more recent example? $20.7 = AMOUNT IN BILLIONS invested in U.S. stock funds in January 2013. Investors are piling back in the stock market at levels not seen in last 12 years Value Guide Stock SOURCES http://uonews.uoregon.edu/archive/news-release/2011/11/researchers-find-risk-taking- behavior-rises-until-age-50 http://themotaxguy.com/blog/your-investment-decisions/ http://www.investopedia.com/features/crashes/crashes2.asp#axzz2JZVNQVUN http://www.mint.com/blog/investing/investing-personality-08092010/ http://newgradlife.blogspot.com/2010/07/15-interesting-facts-about-stock-market.html http://www.mint.com/blog/investing/your-brain-is-your-barrier-to-smart-investing-122011/ http://www.betterinvesting.org/public/startlearning/bi+mag/articles+archives/1007cspublic.htm http://www.onlinemba.com/blog/investing-and-the-brain-how-risk-taking-affects-the-human-mind/ http://www.investopedia.com/features/crashes/crashes3.asp http://lipperinsight.thomsonreuters.com/2013/02/lipper-fund-flows-equity-mutual-fund- flows-hit-levels-unseen-in-nearly-12-years/ http://papers.ssrn.com/sol3/papers.cfm?abstract id=227015 http://www.ajkesslerblog.com/how-to-lose-your-shirt-in-vegas/ http://www.investorwords.com/16526/loss aversion.html#ixzz2K9P8aBGv http://optionalpha.com/following-the-herd-mentality-and-how-it-hurts-your-portfolio-9688.html http://www.businessinsider.com/death-of-equities-revisited-2012-8 http://hbswk.hbs.edu/item/6965.html http://finance.yahoo.com/news/active-equity-outflows-fixed-income-120000349.html http://www.fpanet.org/ToolsResources/ArticlesBooksChecklists/Articles/ FinancialPlanning/TheFallacyofSunkCosts/