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Why your behaviour may dramatically reduce your

returns What evidence do we have?

Frank Ashefrank.ashe@mafc.mq.edu.au

July 2005

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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.

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Return reduction?

• Evidence - studies covering:

• 35,000+ US households’ electronic trades

• 130,000+ Taiwanese investors

• Psychological traits

• Neuroscience

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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

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Overconfidence

• Fill out sheet:

• Compared to the people in this room, are you in the:– Top Third

– Middle third

– Bottom Third

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Psychology

• Summary of recent research in behavioural finance and psychology

• Predominant behaviours:– Representative and availability heuristics– Overconfidence– Herding

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Cognitive biases …Why?

• Limited attention, limited time, limited brain power

• Even simple counting tasks are hard

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Counting task video

• Count the number of times the white team throw the ball to each other.

• How accurately did you count?

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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)

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Representative and availability heuristics (II)

• People buy attention getting stocks

• If it hits the news, then they’re likely to buy

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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

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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’

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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

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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

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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

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Conclusions

• All these studies reinforce the old lesson:

Discipline

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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

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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 Paper http://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, Forthcoming http://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