behavioral finance: ARE FEAR AND GREED DRIVING INVESTOR'S DECISIONS?

Behavioral finance is not an abstract science. It is intended to analyze real investment decisions made every  day by investors. By understanding behavioral motivations behind investment decisions, investors can have a better understanding of how one defines reward, measures risk, and what decisions will lead to the  most satisfying investment outcomes. This webinar is intended to challenge investors to look internally, to evaluate their behavior and how it impacts portfolios. This is not always a comfortable conversation, but it commonly leads to better investment decisions and results.


Much of investment management is based on mathematical models and economic theory. The reality for investors is the emotion plays a large role in investment decisions. Investors’ relationship with money is complicated. How they feel about money influences how they make it, how they spend it, how they invest it. Money can be empowering and intimidating. The emotional cycles that investors experience during regular market cycles can be very similar to the emotions cycles of euphoria and grief. This webinar will walk us through the theory of investment science, and the reality of investors’ actions based on behavioral finance studies.

Investment management is based largely on the concepts developed in Modern Portfolio Theory and The Efficient Market Hypothesis. There are basis principles that guide these theories.

Modern Portfolio Theory assumes:

  1. All investors are risk adverse
  2. Risk must be rewarded
  3. Reward comes in the form of total return
  4. The optimal portfolio maximized total return for each level of tolerated risk

The Efficient Market Hypothesis assumes:

  1. Asset prices have a random walk, not based upon specific time intervals
  2. Asset prices reflect true value with all information priced instantaneously
  3. There is no opportunity to systematically exploit market inefficiencies

In reality, we know that the markets and investors act a bit differently than this. For instance:

  1. Investors are not always rational, think of fear and greed cycles
  2. Asset prices do not always reflect all information, think of bubbles and crashes
  3. Investors are not always risk adverse
  4. Reward can come in many forms, cash flow, tax efficiency, philanthropic benefits
  5. Risk is not always measured the way investment professionals measure it, think of volatility vs. loss of capital
  6. That is where behavioral finance comes in. There are some famous quotes that have almost become clichés in our society that highlight behavioral finance concepts:

A common way to highlight behavior finance is with an experiment that shows that the pain of losing of a dollar is greater than the pleasure of earning a dollar. Be honest on how you would respond to these situations:


Example 1:
Given a choice between a 100% chance at $90,000 or a 10% chance at $0 and a 90% chance at $100,000 studies have shown that most investors will take the sure bet even though, statistically speaking, the expected returns are the same under both scenarios.

Example 2:
Given a choice between a 100% chance at losing $90,000 or a 10% chance of losing $0 and a 90% chance of losing $100,000 studies have shown that most investors will now choose the latter.


Why? When it comes to losing, clients will (unknowingly) pursue risky behavior to avoid loss. Clients are more tolerant of risk when avoiding losses than they are when seeking reward. This is a direct conflict with Modern Portfolio Theory, but fits nicely into the study of behavioral finance. There are some main categories of behavioral finance that will be discussed. Each of these could consume a textbook of analysis. For the purpose of the webinar, we will simply provide come specific examples of the behavior associated with each behavioral finance concept.


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Tuesday, October 20  |  2-3:30 PM

 

To be a better investor, it is not required to eliminate your behavioral finance characteristics. These are what  make investing fun, interesting, satisfying, and rewarding. What makes you a better investor is identifying these behavioral finance concepts in your own decision making process.  

  • Are you only investing in what is familiar to you, and missing new opportunities?  
  • Do you think you are smarter than everybody else involved in the capital markets and, as such,  making decisions that add unnecessary risk to your portfolio?  
  • Do you believe that you can actually time the market better than traders on the floor or firms with  supercomputers?  
  • Are you segregating your portfolio into buckets and missing the big picture?  
  • Are you investing in or avoiding fads, just because?  
  • Have you set specific thresholds to losses or gains that cause you to make inefficient investment  choices?  
  • Can you say “enough is enough” and admit that the idea was not one of your best?  
  • Are you only focused on return, while ignoring risk? Or to the contrary, are you obsessed with  avoiding risk, and as such, missing out on return?  
  • When reviewing your investment decisions, are you looking at both your good ones and bad ones?  
  • How much pain do you feel when losing money vs. pleasure you feel when making money?  

ABOUT RON FLORANCE

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As Senior Strategic Advisor and a member of the Board of Advisors, Ron advises on comprehensive strategic asset allocation, investment strategy and investment solutions. He is responsible for communicating the firm’s global investment strategy at conferences, academic lectures and continuing education programs.

Ron has over 30 years of experience in the investment management industry. His expertise includes global asset allocation, equity research, fixed income research and portfolio design and management. He recently retired as Deputy Chief Investment Officer at Wells Fargo Private Bank. His prior corporate experience included roles at The Vanguard Group, Wells Fargo Nikko Investment Advisors and The Private Bank at Bank of America.

He holds a BA in Applied Mathematics and Economics from Brown University and holds a Chartered Financial Analyst designation.


The views expressed are for general information purposes only and are not intended to provide specific financial advice.

Robertson Stephens Advisors, Robertson Stephens Asset Management, and Robertson Stephens Securities are wholly owned subsidiaries of Robertson Stephens LLC (RS). Investment advice is offered through Robertson Stephens Advisors, a registered investment advisor and securities are offered through Robertson Stephens Securities, Member FINRA/SIPC.