1 Why your behaviour may dramatically reduce your returns What evidence do we have? Frank Ashe 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 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 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 de Waal, F. B. M. (2005) How Animals do Business Scientific American April Kahneman, D. and M. W. Riepe (1998) Aspects of Investor Psychology Journal of Portfolio Management 1998 Summer McClure, S. M., D. I. Laibson, G. Loewenstein and J. D. Cohen (2004) Separate Neural Systems value Immediate and Delayed Monetary Rewards Science Nosfinger, J. R. (2002) The Psychology of Investing Pearson Prentice Hall