man does not need the mortar of truth to seal up the prisons of his fear. montaigne

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

H T T H T H

H H H H H H

Gambler’s fallacy

H T T H T H

H H H H H H

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!

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, PsychologistPrinceton 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?


• Would you rather get $10 a year from now, or $11 a year and a day from now?


• 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?


• 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!


• It seems easier to be patient in the future than in the present.

Two Minds About Time

Ant or Grasshopper???


• 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.


• 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

man does not need the mortar of truth to seal up the prisons of his fear. montaigne

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