Investor psychology aspects of investor psychology for financial advisors

Rohan Dinesh Ghalla | [email protected] | +919819390450

What do you want from today’s session?

What Women Want (2000) *ing Mel Gibson and Helen Hunt

What do Investors Want? (1993 – ongoing)

What do Investors REALLY Want (2012)


Utilitarian Benefit › Returns and what money can finally buy

Expressive Benefit › My tastes, status, values

Emotional Benefit

› Feel safe, excited, hope, dream


IQ of 200 means intelligent or rational? IQ = Logic = Rationality? Why then EQ? and now SQ? Do we use the rational framework?

› Update beliefs for new information – Bayes › Make normatively acceptable choices

rational choices? Thinking fast and slow › Perfect Self Interest › Perfect Information


The Tree of Biases

Cognitive

Belief Perseverance (6)

Cognitive Dissonance

Conservatism

Confirmation

Representativeness

Illusion of Control

Hindsight

Information Processing (7)

Anchoring and Adjustment

Mental Accounting

Framing

Availability

Self Attribution Bias

Outcome Bias

Recency Bias

Emotional

(7)

Loss Aversion

Overconfidence

Self Control

Status Quo

Endowment

Regret Aversion

Affinity


Bias Type: Cognitive Subtype: Belief Perseverance Basic building block of off belief

perseverance biases When newly acquired information conflicts

with preexisting understandings people often experience mental discomfort

Purchase the iPhone 5 only to see the launch of the Galaxy S4 – go to great pains to justify initial purchase


Bias Type: Cognitive Subtype: Belief Perseverance Mental process in which people cling to

their prior views or forecasts at the expense of acknowledging new information

Difficulty in processing new information, reacting slowly to new information


Bias Type: Cognitive Subtype: Belief Perseverance Type of selective perception that

emphasizes ideas the confirm our beliefs while devaluing whatever contradicts our beliefs


Bias Type: Cognitive Subtype: Belief Perseverance When confronted with a new

phenomenon that is inconsistent with any preconstructed classifications, people subject it to those classifications anyway, relying on a rough, best fit approximation


Bias Type: Cognitive Subtype: Belief Perseverance Tendency to believe that we can control

or atleast influence the outcomes Las Vegas Gambling Comfort with risky involvement / private

funding if done directly


Bias Type: Cognitive Subtype: Belief Perseverance Once an event has elapsed, people

tend to perceive that the event was predictable – even if it wasn’t

Actual outcomes are more readily grasped by peoples minds than the infinite array of outcomes that could have but didn’t materialize


Bias Type: Cognitive Subtype: Information Processing Tendency to code, categorize and

evaluate economic outcomes by grouping assets into non-fungible mental accounts

$30 and $9 gamble example Goals based investing


Bias Type: Cognitive Subtype: Information Processing When required to estimate the value

with unknown magnitude, people begin by envisioning some initial default number which becomes an anchor which they adjust up or down to reflect subsequent information and analysis

Purchase price anchoring Earnings estimates and revisions Rohan Dinesh Ghalla | [email protected] | +919819390450

Bias Type: Cognitive Subtype: Information Processing Respond to situations differently based

on how something is presented Narrow Framing and Broad Framing

› Wealth and Profits Absolute versus relative performance


Bias Type: Cognitive Subtype: Information Processing Rule of thumb or mental shortcut that

causes people to estimate the probability of an outcome based on how prevalent or familiar that outcome appears in life

Air travel insurance Property prices always go up Home country and investment bias Rohan Dinesh Ghalla | [email protected] | +919819390450

Bias Type: Cognitive Subtype: Information Processing Heads I win, tails its’ chance! Tendency to ascribe success to innate

aspects of the individual such as talent and foresight and blame failures on outside influences and luck


Bias Type: Cognitive Subtype: Information Processing Decision based on outcome of past

events and actual outcomes rather than process for achieving the outcome

Understanding of what is important Skill vs Luck


Bias Type: Cognitive Subtype: Information Processing More prominently recall recent events

and observations than those that occurred in the distant past

Its different this time


Bias Type: Emotional Prospect theory Stronger impulse to avoid losses than to

acquire gains


Bias Type: Emotional Unwarranted faith in ones intuitive

reasoning, judgments and cognitive abilities

Emotionally charged behaviour such as rash driving, excessive risk taking


Bias Type: Emotional Lack of discipline and self control Fail to act in pursuit of long term

overarching goals because of a lack of discipline

Inability to start saving young Important vs Urgent distinction


Bias Type: Emotional Choice based on whatever option

ratifies or extends the existing condition If a portfolio is built, very difficult to

change it dramatically Selling stocks once they have been

bought


Bias Type: Emotional Value an asset more when it belongs to

you rather than when it is not in the persons possession

Minimum selling price for something is more than the minimum purchase price for the same thing

Inherited assets vs purchased assets


Bias Type: Emotional Avoid taking decisive actions because

of the fear that the course selected will prove less than optimal

Avoid the emotional pain of regret associated with poor decision making

Staying out of market after a loss Holding losing positions too long Herd behaviour


Bias Type: Emotional Choice made based on how one

believes that a certain product or service will reflect their values to others

Expressive benefits of a product than on what it actually does


A bat and a ball together cost $1.10. The bat costs $1.00 more than the ball. How much does the ball cost?

Are you an above average driver? If it takes 5 machines 5 minutes to make

5 widgets, how long would it take 100 machines to make 100 widgets?


A health survey was conducted in a sample of adult males in Bombay, of all ages and occupations. Please give your best estimates of the following values: › What percentage of the men surveyed have

had one or more heart attacks? › What percentage of the men surveyed are

both over 55 and have had one or more heart attacks?


Imagine these are four playing cards laid out in front of you. Each one has a letter on one side and a number on the other. If a card has an E, it should have a 4. Which cards do you need to turn over in order to see if I am telling the truth?


Suppose an unbiased coin is flipped three times, and each time the coin lands on heads. If you had to bet $1000 on the next toss, what side would choose? Heads, tails or no preference?


Imagine that the Bombay is preparing for the outbreak of an unusual disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. Assume the exact scientific estimates of the consequences of the programs are as follows:


If program A is adopted 200 people will be saved.

If program B is adopted there is a 1/3 probability that 600 people will be saved, and a 2/3 probability that no one will be saved.

Which program do you choose?


Linda is 31 years old, single, outspoken, and very bright. She majored in Philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations


Which statement is more likely? › Linda is a bank teller › Linda is a bank teller and is active in the

feminist movement Would you want to be Linda’s friend?


You are now going to play a game against the others sitting in this room. The game is simply this. Pick a number between 0 and 100. The winner of the game will be the person who guesses the number closest to two thirds of the average number picked. Your guess is?


If program C is adopted 400 people will die.

If program D is adopted there is a 1/3 probability that nobody will die, and a 2/3 probability that 600 people will die.



In addition to what you already own, you have been give Rs. 1000. Now choose between › A – A 50% chance of winning Rs. 1000 more › B – Winning Rs. 500 for SURE. 100%


In addition to what you already own, you have been give Rs. 2000. Now choose between › C – A 50% chance of LOSING Rs. 1000 › D – LOSING Rs. 500 for SURE. 100%


Where in the spectrum are you?


A bat and a ball together cost $1.10. The bat costs $1.00 more than the ball. How much does the ball cost?

Are you an above average driver? If it takes 5 machines 5 minutes to make

5 widgets, how long would it take 100 machines to make 100 widgets?


A health survey was conducted in a sample of adult males in Bombay, of all ages and occupations. Please give your best estimates of the following values: › What percentage of the men surveyed have

had one or more heart attacks? › What percentage of the men surveyed are

both over 55 and have had one or more heart attacks?


Imagine these are four playing cards laid out in front of you. Each one has a letter on one side and a number on the other. If a card has an E, it should have a 4. Which cards do you need to turn over in order to see if I am telling the truth?


Suppose an unbiased coin is flipped three times, and each time the coin lands on heads. If you had to bet $1000 on the next toss, what side would choose? Heads, tails or no preference?


Imagine that the Bombay is preparing for the outbreak of an unusual disease, which is expected to kill 600 people. Two alternative programs to combat the disease have been proposed. Assume the exact scientific estimates of the consequences of the programs are as follows:


If program A is adopted 200 people will be saved.

If program B is adopted there is a 1/3 probability that 600 people will be saved, and a 2/3 probability that no one will be saved.



If program C is adopted 400 people will die.

If program D is adopted there is a 1/3 probability that nobody will die, and a 2/3 probability that 600 people will die.



Linda is 31 years old, single, outspoken, and very bright. She majored in Philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations


Which statement is more likely? › Linda is a bank teller › Linda is a bank teller and is active in the

feminist movement Would you want to be Linda’s friend?


You are now going to play a game against the others sitting in this room. The game is simply this. Pick a number between 0 and 100. The winner of the game will be the person who guesses the number closest to two thirds of the average number picked. Your guess is?


In addition to what you already own, you have been give Rs. 1000. Now choose between › A – 50% chance of winning Rs. 1000 more › B – Winning Rs. 500 for SURE. 100%


In addition to what you already own, you have been give Rs. 2000. Now choose between › C – A 50% chance of LOSING Rs. 1000 › D – LOSING Rs. 500 for SURE. 100%


Work on a ADAPT or MODERATE model


Encourage clients to adopt a broad view of their wealth, prospects and objectives.

Encourage clients to make long-term commitments to policies

Encourage clients not to monitor results too frequently

Discuss the possibility of future regret with your clients


Ask yourself if a course of action is ‘out of character’ for your client

Verify that the client has a realistic view of the odds, when a normally cautious investor is attracted to a risky venture

Encourage the client to adopt different attitudes to risk for small and for large decisions


Attempt to structure the client’s portfolio to the ‘shape’ that the client likes best (such as insuring a decent return with a small chance of large gain)

Make clients aware of the uncertainty involved in investment decisions

Identify the aversion of your clients to the different aspects of risk, and incorporate their risk aversions when structuring an investment program.


Behaviorally Yours

Rohan Dinesh Ghalla

[email protected]

+91 98193 90450

Credits: Michael Pompian and James Montier across their various publications


mailto:[email protected]

Investor psychology aspects of investor psychology for financial advisors

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