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Behavioral Finance: Are Your Emotions Costing You Money?

Behavioral Finance: Are Your Emotions Costing You Money?
by

Ara Oghoorian

on 24 January 2012

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Transcript of Behavioral Finance: Are Your Emotions Costing You Money?

Anchoring Behavioral Bias

1. Mental accounting
Compartmentalize assets into different pools: Vegas money, bonuses, birthday money, tax refund

2. Anchoring
Attached to first impressions
Unwilling to accept new information

3. Overconfidence
Overestimate their ability to measure data
Overconfident investors take more risk Are Your Emotions Costing You Money?

Ara Oghoorian, CFA, CFP®
www.acapam.com Human Emotions Think Critically Long Term Memory Behavioral
Finance 1. Investors Avoid Risk (Risk Averse)
- Understand risk/return are related

2. Investors Diversify
- Look at portfolio as a whole

3. Investors Are Rational
- Don't let their emotions interfere Behavioral Finance Shows

1. Avoid losses (BF) versus Avoid Risk (TF)

2. Don't diversify (BF) versus (TF)

3. Are Irrational (BF) versus Rational (TF) Meet Jimmy
Invests in a company that makes money
Buys Cisco for $10 per share in mid 1990s Overconfidence Bias Starts to think he's a good stock picker Today's Roadmap 1.
Define Traditional Finance and its Assumptions 2.
Define Behavioral Finance
Vs.
Traditional Finance 3.
Identify Behavioral Biases and Their Consequences 4.
Discuss How to Overcome Biases Begins to buy more technology stocks Starts bragging at cocktail parties Traditional Finance Anchoring Bias
Sean is fixated on $32
He thinks everyone else is wrong
Sean seeks information that supports his viewpoint
He starts to trade more
Feels regret for not selling earlier Consequences of Biases Increased stress due to volatility How to Overcome Biases Traditional Finance Assumptions Status Quo Sunk Cost Herding Regret Home Bias 1/n diversification Overconfidence Mental Accounting Over concentrated portfolios Illusion of control Unwilling to accept new information Thinking short term when investing is supposed to be long term Avoid sensationalism
Meant to incite, not inform
Causes investors to be more emotional Read contradictory news
Recognize that there are differing viewpoints
Anchoring trap
Give equal weight
Buffett way Don't look at your portfolio every day
Trade more
Incur more risk
Successful investors don't watch the markets every day
Develop and follow a plan Hire a Fee-Only financial advisor
Does not work on commission
Does not sell products
Acts as a fiduciary
Is an investment professional, not a salesperson How a Fee-Only financial advisor can help
Separates your emotions from your investment decisions
Develops a written financial plan specific to your needs
Ensures your investments are commensurate with your risk tolerance
Delegate: Lets you focus on your family, work, and hobbies
Separates your emotions from your investment decisions
Full transcript