Behavioral Finance is Alive and Well

An article in last month’s MorningstarAdvisor  provides a “brief tour through the history of behavioral finance” and offers some insights as to what might lie ahead. “Behavioral finance as a distinct approach is very much alive and well, and it is being applied in a variety of contexts within the industry,” writes Morningstar’s Steve Wendel, who oversees a team of researchers dedicated to developing “behavioral tools to help investors in an increasingly complicated market.” Wendel cites some of the key players in this field of study as well as some major findings with respect to biases and other relevant factors. […]

Ritholtz Says Stock-Picking is Still Alive if Not Kicking

Active fund management has been losing followers but isn’t going away entirely, writes Barry Ritholtz in a recent Bloomberg article. While stock-picking has seen a host of changes, he offers several insights as to “how we got here” including the following: Beating the market is tougher than most people thought, a notion that Ritholtz says has become “widely accepted among both professional investors and individuals.” We have a much greater understanding of investor psychology, and this “makes the case for low-cost index investing even more compelling.” Quantitative studies, writes Ritholtz, suggest that much of active investing performance is attributable to […]

Jason Zweig on Investing Fact Versus Fiction

The human mind seeks to “confirm its pre-existing beliefs while ignoring warning signs that we might be wrong,” writes Jason Zweig of The Wall Street Journal. He uses the example of the surprise Trump win to illustrate how people avoid admitting that they were wrong. “If it requires fibbing to ourselves,” writes Zweig, “so be it.” Psychologists define the brain’s tendencies using the terms confirmation bias and hindsight bias. The first drives us to find support for our pre-conceived notions, and the second compels us to believe that, once an outcome is known, we knew it was coming. Zweig writes, […]

The Trading Effect

In psychology and behavioral economics, the endowment effect is the hypothesis that people assign more value to things they own. Past studies have shown that experienced securities traders are less susceptible to this bias but the reasons have been unclear. However, researchers at the University of Chicago recently published results of several experiments which suggest the cause, as reported in last week’s UChicago News. According to study findings, when experienced traders are selling they have “reduced activity in the area of the brain often associated with pain and negative emotions,” thus allowing them to demand a higher price to sell a good than […]

Asness and Arnott Talk Market Timing, Smart Beta and Behavioral Biases

Maybe not always. At least that was the upshot of a debate between Cliff Asness of AQR and Rob Arnott of Research Affiliates, panelists at the recent Morningstar conference in Chicago. Although they debated various topics, they seemed to agree that value stocks deserve attention when they’re cheap. According to Asness, founder and managing principal at AQR, “Timing the market is hard and we call it a sin, but we recommend that investors sin a little.” The panelists discussed the pros and cons of smart beta strategies, generally agreeing on most points. “The point of our whole exercise is check […]

Understanding the Behavioral Continuum on Your Way to Becoming a Better Investor

Shreenivas Kunte, director of content at the CFA Institute, recently wrote about the Behavioral Continuum and how it affects our decision making process. He contends that “behavioral patterns extend across a wide continuum. On the darker side, they can generate negativity or lead to disaster. On the lighter side, they are useful, even essential.” Thus, Kunte cautions that “being mindful about the structure and continuum of these patterns and their potential paradoxes is critical for investment decision makers.” He addresses the following four behavior biases: skepticism, optimism, status quo, and pessimism. Skepticism is ” the ability to doubt, to question, […]

Emotions and Biases Play Huge Role in Bad Investment Decisions

In a recent New York Times article, columnist Gary Belsky observes that “the majority of cognitive biases and shortcuts that influence everyday judgement and choice have analogues in investment behavior.” In other words, insights from behavioral economics and finance explain why people don’t often behave rationally when investing. For example, amateur investors believe they can outperform the professionals, largely because of cognitive biases. The article highlights several, such as overconfidence and optimism biases, as described below. Overconfidence bias is the tendency to overrate one’s abilities, knowledge, and skill. Mirtha Kastrapeli of State Street described overconfidence found in a 2014 study: […]

Grantham Says Our Bias Toward Good News Makes Us Manipulable

In a recent Barron’s excerpt of a longer article, Jeremy Grantham, founder of asset management firm GMO, says Americans “have a broad and heavy bias away from unpleasant data” that makes us “ready to be manipulated by vested interests in finance, economics, and climate change, whose interests might be better served by our believing optimistic stuff ‘that just ain’t so.’” He points to a few examples of propositions that are “widely accepted by an educated business audience . . . but totally wrong.” His examples include the widely held business audience assumption about “how incompetent at business the French are […]

Working through the Pain for the Best Long Term Gain

  In a Financial Planning article titled “Investing Should Be Painful,” founder of research firm Wealth Logic, LLC Alan Roth writes, “I suggest telling clients to embrace the pain and take it as a good sign.” This approach reflects insights from psychology and behavioral finance.  The “pain” Roth is referring to comes from going against the cognitive biases of the human brain. Borrowing from Nobel Laureate Daniel Kahneman and others, Roth describes the more automatic and emotional “system 1” thinking (in contrast to the slower, more effortful and logical “system 2” thinking) as the source of the pain investors feel […]

How Your Brain Hurts Your Returns – And What You Can Do To Stop It

What’s the biggest obstacle to investment success? Validea’s John Reese says it may well be our own brains. “The capabilities of human beings’ brains are staggering,” Reese writes in his latest piece for Forbes.com. “Over the course of many millennia, the development of our brains has allowed us to outsmart dangerous predators, build enormous cities and create complex machines like computers and automobiles. Our brains let us think abstractly, plan for the future and create emotion-provoking art and music.” “But,” he continues, “when it comes to investing, our brains have us hardwired to fail.” He says that our alertness to […]

Don’t Get Spooked By Value Stocks

Value stocks may have underperformed growth stocks for several years now, but Validea CEO John Reese says investors would be wise not to pronounce value investing dead anytime soon. “Given that it’s Halloween season, it seems appropriate that value stocks are starting to stage a comeback in the United States,” Reese writes in his latest column for Canada’s Globe and Mail. “Much like the villain in a scary slasher flick, value stocks have been beaten, battered and, by many, presumed dead. They’ve been losing to growth stocks since mid-2006, marking the longest stretch of imbalance in the growth/value cycle in […]

How Your Brain Hurts Your Returns — And What You Can Do To Stop It

What’s the biggest obstacle to investment success? Validea’s John Reese says it may well be our own brains. “The capabilities of human beings’ brains are staggering,” Reese writes in his latest piece for Forbes.com. “Over the course of many millennia, the development of our brains has allowed us to outsmart dangerous predators, build enormous cities and create complex machines like computers and automobiles. Our brains let us think abstractly, plan for the future and create emotion-provoking art and music.” “But,” he continues, “when it comes to investing, our brains have us hardwired to fail.” He says that our alertness to […]

Mauboussin: Understanding the Process Can Help Separate Luck and Skill in Investing

AAII editor Charles Rotblut, CFA, interviewed Michael Mauboussin, head of Global Financial Strategies at Credit Suisse, about the role of both luck and skill in investing (subscription required). According to Mauboussin, to separate skill from luck, you first have to look at the process that generates the output you are looking to achieve. In order to assess the process, you need to look at three important elements: Analytical: “having an ability to find situations in which you believe something the world doesn’t believe and in which you have a good foundation for such a belief. Behavioral: “we are all subject […]