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Why your behaviour may dramatically reduce your returns What evidence do we have?

Why your behaviour may dramatically reduce your returns What evidence do we have?. Frank Ashe frank.ashe@mafc.mq.edu.au July 2005. I make flexible but disciplined investment judgments, taking into account my overall financial position, my tax status, and my informed view of the markets.

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Why your behaviour may dramatically reduce your returns What evidence do we have?

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  1. Why your behaviour may dramatically reduce your returns What evidence do we have? Frank Ashe frank.ashe@mafc.mq.edu.au July 2005

  2. I make flexible but disciplined investment judgments, taking into account my overall financial position, my tax status, and my informed view of the markets. This enables better performance, for me, than a high cost external advisor would be able to achieve.

  3. Return reduction? • Evidence - studies covering: • 35,000+ US households’ electronic trades • 130,000+ Taiwanese investors • Psychological traits • Neuroscience

  4. Overconfidence - results • Individual traders are way too confident • Sell winners, hold onto losers • Their set and forget portfolios outperform their traded portfolios • Transaction costs chew up returns • Men trade more than women, have riskier portfolios, and significantly underperform

  5. Overconfidence • Fill out sheet: • Compared to the people in this room, are you in the: • Top Third • Middle third • Bottom Third

  6. Psychology • Summary of recent research in behavioural finance and psychology • Predominant behaviours: • Representative and availability heuristics • Overconfidence • Herding

  7. Cognitive biases …Why? • Limited attention, limited time, limited brain power • Even simple counting tasks are hard

  8. Counting task video • Count the number of times the white team throw the ball to each other. • How accurately did you count?

  9. Representative and availability heuristics (I) • People don’t (can’t) use all the data • They use the available (simply recalled) and representative data (over-reliance on small samples)

  10. Representative and availability heuristics (II) • People buy attention getting stocks • If it hits the news, then they’re likely to buy

  11. Herding (I) • Something is more attractive if you know other people like it • Other’s perceived, average asset allocation is preferred • Representative bias reinforces trends

  12. Herding (II) • Who’s in hedge funds these days? • Who wants today’s hot manager? • Fund managers in same city prefer same stocks • Equity managers’ relative performances is too highly correlated – so are bond managers’

  13. Overconfidence • Men are more confident than women • Examining 35,000 portfolios: • Women’s portfolios outperform men’s • 1.1% per annum for individual traders • Women have less risky portfolios

  14. Overconfidence • Young and single people are more overconfident than older and married • Hold more volatile stocks • Trading decreases as we age, but only slightly (performance increases) • Young single men trade the most and have the worst performance

  15. Neuroscience • Long and short-term financial decisions are made in different parts of the brain • Long-term decisions are more closely linked to rational part of brain • Short-term decisions are more closely linked to emotions

  16. Conclusions • All these studies reinforce the old lesson: Discipline

  17. Conclusions (II) • Don’t read the news • Don’t trade • Get married • Give the portfolio to the wife • Don’t talk finance with your friends • Don’t get emotionally involved • Think twice before selling your winners and holding your losers

  18. References • Barber, B. M. and T. Odean (2001) Boys will be Boys: Gender, Overconfidence, and Common Stock Investment Quarterly Journal of Economics 116 1 261- • Barber, B. M. and T. Odean (2005) All that Glitters: The Effect of Attention and News on the Buying Behavior of Individual and Institutional Investors EFA 2005 Moscow Meetings Paperhttp://ssrn.com/abstract=460660 • Barberis, N. and R. Thaler (2002) A Survey of Behavioral Finance National Bureau of Economic Research (NBER) NBER Working Paper 9222 • Camerer, C. F., G. F. Loewenstein and D. Prelec (2004) Neuroeconomics: How Neuroscience Can Inform Economics Journal of Economic Literature, Forthcominghttp://ssrn.com/abstract=590965 • de Waal, F. B. M. (2005) How Animals do Business Scientific American April 54-61 • Kahneman, D. and M. W. Riepe (1998) Aspects of Investor Psychology Journal of Portfolio Management 1998 Summer 52-65 • McClure, S. M., D. I. Laibson, G. Loewenstein and J. D. Cohen (2004) Separate Neural Systems value Immediate and Delayed Monetary Rewards Science 306 503-507 • Nosfinger, J. R. (2002) The Psychology of Investing Pearson Prentice Hall

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