Investing, IRAs, and Behavioral Finance

BTB 1025Matthew Zimpelman

Richard SegalKevin Smeaton

Why Invest?

https://www.youtube.com/watch?v=tp6n8ChUPZA

Understand your risk tolerance

Understanding Bonds

How Bonds Work Coupon Rate vs. Interest Rate Receive invested amount at end of duration

Types of Bonds Treasury (Government) Bonds: low risk, low return Municipal Bonds: tax-free interest Corporate Bonds: higher risk, higher return

Important Factors when Choosing a Bond

Pricing Discount Premium Par Value

Duration

Coupon Rate

Depends on Risk Tolerance

Understanding Stocks

What are stocks? Ownership in a corporation

Buy Low, Sell High Understand Return

Dividends A distribution of a portion of a company's earnings, decided by

the board of directors, to a class of its shareholders.

Shorting Stocks = Betting against a company Sell High, Buy Low Example

Average Return on Stock Market = 10-11%

Long Term Investing Tips

Diversification Investment types (Bonds vs. stocks vs. other

investment types) Market type (Ex: automobile market)

Be Patient Don’t track daily, weekly, monthly changes Some years you might lose money, don’t worry

Invest Earlier = More Money = Retire Earlier!

Long Term Investment Scenario

http://www.daveramsey.com/article/how-teens-can-become-millionaires/lifeandmoney_kidsandmoney/

Who Wants to Be a Millionaire?

If you took $1,000 and invested it, what would happen?

If you waited for 50 years, you could be a millionaire!!!! (Or at very least a hundred-thousand-aire!))

How??? Compounding Interest and Smart Investing! What is compounding interest?

Return Rates Historical Average Return on the Stock Market = 11% Aggressive Approach (Good Investing) = 15%

Path to Becoming a Millionaire!

Year Total Amount: Avg. Market Rate Return = 11%

Total Amount:Aggressive Approach/ Return = 15%

0 $1,000.00 $1,000.00

1 $1,100.00 $1,150.00

2 $1,232,00 $1,322,50

10 $2,839.4 $4,045.56

20 $8,062.3 $16,366.54

35 $38,574.85 $133,175.52

50 $184,564.83 $1,083,657.44

Retirement Planning

Save now in order to retire at younger age

Money growth is exponential

Different forms of retirement accounts: Benefit Plans (employer sponsored) Traditional IRAs Roth IRAs

IRA—individual retirement account Personal account that works similar to benefit plan

Benefit Plans Most common is a 401k plan

Contributions made by employee into the firm’s plan Sometimes employer will match your contributions up to

a certain amount If possible, ALWAYS contribute the MAXIMUM that the

employer will match

Earnings are tax deferred Major benefit due to compound interest

403b plan (non-profit organizations

457b plan (governmental employers)

Traditional IRA

Personal retirement account

Each person allowed to contribute max $5,500

Age 50+, can contribute additional $1,000 as “catch up”

Earnings are tax deferred until withdrawn Compound interest on larger sum of money

Because it isn’t being taxed today Good if tax rate is lower when money is withdrawn

Roth IRA

Also a personal retirement account

Max contribution is also $5,500

Age 50+, can contribute additional $1,000 as “catch up”

Earnings are taxed when earned Do not pay taxes when withdraw funds Good if tax rate increases over time

What is Behavioral Finance?

“The area of finance dealing with the implications of investor reasoning errors on investment decisions

and market prices”● Reasoning Errors Occur by Investors● Proponents of behavioral finance believe these

errors cause market inefficiencies

Introductory Activity

We give you $4000. Next, you can take one of the following two options: A. You can have $1000 more dollars from usB. You can flip a coin. If it lands on heads, you

get $2000 more from us. Tails, you get nothing.

Introductory Activity 2

We give you $6000. Next, you can take one of the following two options: A. You can lose $1000B. You can flip a coin. Heads, you lose $2000.

Tails, you lose nothing

Frame Dependence

Both scenarios we went through were exactly the same. ● Option A: You would have ended up with

$5000● Option B: 50% chance you would have

ended up with $6000, and 50% chance of getting $4000

Therefore, you should chose the same answer in both scenarios. Why didn’t you?

Loss Aversion

● Reluctance to selling investments after they fall in value

● Always evaluate stocks at their current priceo Do not base on past prices

● Barings Bank and Nicholas Leeson● Individual 1.5 times more likely to sell a gain

then sell a loss

Overconfidence

● Overconfidence leads to more tradingo more trades leads to lower relative returns

● Overtrading is “a guy thing”o men trade about 50% more than womeno men have riskier portfolios than women

● 43% of households outperform marketo lack of diversification

Misperceiving Randomness

The Hot Hand Fallacy: Common misconception in sports:

If player is doing well, he should continue to do well? Stats show that having “hot hand” does not increase

chances of staying “hot”

Coin flip activity You flip the coin one more time, do you think it will

it be heads or tails?

Overreacting to Chance

● The Gambler’s Fallacy: o The idea that if an event hasn’t happened recently

it is “overdue” and is bound to happen soon

● These types of cognitive errors are called “forecasting errors”

Works Cited

The Motely Fool http://www.fool.com/teens/teens01.htm

Jordan, Bradford, Thomas Miller, Jr., and Steven Dolvin. Fundamentals of Investments. 7th ed McGrawHill, 2015. Print. ("Hedge Fund Definition | Investopedia." Investopedia. N.p., n.d. Web. 23 Sept. 2014.)