HARD WIRED TO FAIL. Why smart people fail at investing. MacGregor Hall, CIMA

Transcription

1 HARD WIRED TO FAIL Why smart people fail at investing MacGregor Hall, CIMA

2 We ve made great strides in investment theory Proved definitive factors that explain market forces and returns (Fama French), size, price, momentum, etc. Proved markets are efficient. Devised elaborate investment products and schemes: mutual funds, ETFs, hedge funds, alternatives, life strategy and life cycle funds, automatic enrollment. 2

3 But It hasn t helped the average investor: Still have inadequate savings rates Poor investment returns compared to the markets Why? 3

4 Traditional Finance Theory Investors are rational. They make decisions based on complete and accurate data. Markets are, therefore, made up of informed investors and efficient. Returns are a mathematical by product of rational risk/return trade offs. 4

5 5 Traditional Finance Theory

6 Was improved upon by financial theorists 6

7 Modern Portfolio Theory Past performance is no guarantee of future results. Risk and return are measured by standard deviation and arithmetic mean, respectively. This is for illustrative purposes only and not indicative of any investment. An investment cannot be made directly in an index Morningstar. All Rights Reserved.

8 Traditional Financial Theory Investors save and spend according to predictable, rational lifecycle patterns. 8

9 Typical Investor Savings and Spending Cycle Rate of Saving/Spending 10% 8% 6% 4% 2% 0% 2% 4% 6% 8% 10% Age Making investment products predictable & effective: (life cycle funds)

10 Despite this knowledge, we haven t moved the needle on investor success. Why?

11 11 New Behavior Finance Theory Investors are normal. Decisions are made with less than perfect data. Subject to all sorts of human behavioral influences. o Loss aversion, greed, overconfidence, recency bias, regret and the worst HINDSIGHT! Returns are, therefore, unpredictable and dependent on dynamic behavioral actions of investors at any time. Savings and spending needs/patterns aren t predictable and don t conform to lifecycle norms.

12 12 What can we do with this knowledge? Understand the problem & investor behavior. o Investors are 2.5 times more sensitive to loss than gains (think total loss). o They don t like giving up on things they have invested in (hold on to losers). o They regret decisions BEFORE they make them. o They use recency and hindsight to confirm decisions not based on unbiased information. o Emotions influence concrete opinions of what should happen. o They regret losses but also at missing out on gains. o They believe that substituting works. Selling one thing for another

13 In short, we are all hard wired to fail at being rational investors.

14 What can we do? Understand normal investors have normal wants. I have money for retirement. I am financially secure (family). I have freedom from the fear of being poor. I have hopes to be rich. 14

15 SEI Study* 1. Financial security 2. Children/education 3. To Buy things I need/want 4. Improve social status 5. Leave a legacy *Priority rankings of investors about wealth. 15

16 Normal Investors Want to save for tomorrow but actually spend for today. Want to buy low and stay the course but often sell high and change course along the way. Mentally account for savings and goals (spend from one account but not another). 16

17 How can we apply this knowledge? Make it easy to save. Simplify investment decisions Use behavioral tendencies to achieve desired outcomes. 17

18

19

20

21 How can we apply this knowledge? Devise and implement saving mechanisms that adhere to behavioral finance findings. OLD Voluntary Savings Voluntary DC Savings (401k) Social Security NEW Voluntary Savings Mandatory DC Savings (401k) Social Security 21

22 What can we do now? Implement more automatic programs for base level savings using opt out strategies. Implement savings escalations that are automatic. Decrease personal choice options. Increase diversified one step solutions: diversified portfolios based on age and risk (lifecycle). Develop better fixed income products for retirees. Permanently fix Social Security. 22

23 They key to success is changing our thinking and the savingsinvesting paradigm. We aren t rational saving and investing machines. We re human beings with flaws. Let s take advantage of ourselves by applying behavioral finance to our practices and help all investors improve and succeed. 23

24 CONTACT US MacGregor Hall, CIMA President Mike Walters, CRPC Retirement Plan Consultant Deschutes Investment Consulting LLC 200 SW Market Street, Suite 550 Portland, OR