Investor psychology aspects of investor psychology for financial advisors

Rohan Dinesh Ghalla | rohan@leapgrowth.com | +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

 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

 Type of selective perception that
emphasizes ideas the confirm our beliefs
while devaluing whatever contradicts
our beliefs

 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

 Tendency to believe that we can control
or atleast influence the outcomes
 Las Vegas Gambling
 Comfort with risky involvement / private
funding if done directly

 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

 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

 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

 Respond to situations differently based
on how something is presented
 Narrow Framing and Broad Framing
› Wealth and Profits
 Absolute versus relative performance

 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

 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

 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

 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

 Unwarranted faith in ones intuitive
reasoning, judgments and cognitive
abilities
 Emotionally charged behaviour such as
rash driving, excessive risk taking

 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

 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

 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

 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

 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.
 Which program do you choose?

 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%

choose between
› C – A 50% chance of LOSING Rs. 1000
› D – LOSING Rs. 500 for SURE. 100%

 Where in the spectrum are you?

choose between
› A – 50% chance of winning Rs. 1000 more
› B – Winning 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
rohan@leapgrowth.com
+91 98193 90450
Credits: Michael Pompian and James Montier across their various
publications

Investor psychology aspects of investor psychology for financial advisors

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