Source: magazineart.org
Dear Friends and Clients,
Bad habits can lead to lumps of coal in those Christmas stockings. Judging by the vintage advertisement above, even Santa was guilty of bad behavior; specifically, ‘cognitive dissonance’. Over the past twenty years, the study of behavioral economics has expanded, one which is devoted to examining human traits and cognitive biases in decision making. This is important because, after all, markets are nothing more than the collective beliefs and actions of their participants. Your shares of Apple or Amazon are only worth what another person is willing and able to pay. When that person is optimistic, he or she may not mind paying a high price. If, on the other hand, they are worried or fearful, they may decide to sell their shares the same time as you.
Having evolved over thousands of years, we humans have developed behavioral traits and biases which have allowed us to survive. Unfortunately, these same traits are often detrimental to our investment performance and decision making.
A few examples:
Need – The need for yield can cause investors to overpay for stocks and bonds. Remember the time you grabbed that $8.00 Snickers bar from the hotel mini-bar?
Fear - Everyone knows this one. Warren Buffett suggests, “Be greedy when others are fearful.”
Greed - Also understood. Again, advice from Buffett; “Be fearful when others are greedy.”
Cognitive Dissonance - Beliefs clash with evidence. Evidence loses the contest.
Herding - Doing what everyone else is doing feels comfortable.
Confirmation Bias - Preference for information that confirms existing beliefs. Conservatives watch Fox News. Liberals watch MSNBC.
Recency Bias - Belief that the next six months will be like the last six.
Anchoring Bias - Too much focus on initial information, and reluctance to consider new information. An example … those big dollar figures you see during car and truck commercials are displayed as ‘savings’, not the final price.
Familiarity Bias - The status quo feels good. Investors keeps money in ‘what they think they know’ instead of being objective about current holdings or other opportunities.
Survivorship/Hindsight Bias - “It was so easy … I should have bought Amazon at $10.00 a share!” For every Amazon, there are hundreds of companies that augured into the ground, their names long forgotten.
As cartoonist Walt Kelly once wrote, “We have met the enemy … and he is us.”
Merry Christmas, Happy Hanukkah, and Seasons Greetings to all.
If you enjoy my monthly missives, please share them with a friend. If you don’t, please let me know. My office hours are typically 7:30 AM - 4:00 PM. Pick up the phone and share what’s on your mind. In the meantime, I greatly appreciate your trust and friendship, and thank you for the opportunity to be of service.
Copyright © 2020 - Any opinions are those of James Aldendifer and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The above situation is a hypothetical example for illustration purpose only and does not represent an actual investment. Expressions of opinion as of this date are subject to change without notice. There is no guarantee that these statements, opinions, or forecasts provided herein will prove to be correct.
