Join Early Retirement Today
Reply
 
Thread Tools Search this Thread Display Modes
More behavioral finance
Old 10-26-2006, 05:00 PM   #1
Moderator Emeritus
Martha's Avatar
 
Join Date: Feb 2004
Location: minnesota
Posts: 13,212
More behavioral finance

Clements’ article in the WSJ this week was fun. He looked at evolutionary psychology for reasons why people make so many financial mistakes. Sorry, no link as the WSJ is subscription only site.

From Terry Burnham, the author of Mean Markets and Lizard Brains and Robert Frank, the author of Luxury Fever, comes the idea that our instincts are out of step with modern financial life, so we tend to make mistakes, such as:

--we keep striving for bigger houses, fancier cars, bigger paychecks even though research suggests these won’t make us happier in the long run. We do this because our ancestors that survived and reproduced had the greatest drive. There is nothing that tells us to stop as we are "maximizing machines."

--Our ancestors were best served by consuming all they could immediately. Hang on to food? It would rot. Hence the difficulty in saving. “Because saving is such a new concept for us, some folks save too much—and many save way too little.”

--The pain we get from losing $1000 is greater than the pleasure we get from gaining $1000. This causes many people to shy away from stocks, worrying about the risk. The evolutionary roots may be the importance of retaining territory outweighing any need to gain new territory.

--The last point was the need of our ancestors to be good at spotting patterns, like where to fish and get other food. But hunting for patterns can be a disaster in the stock market. If something is too popular, it will be overpriced.

Animal instincts? Maybe, maybe not, but it is fun reading.
__________________

__________________
.


No more lawyer stuff, no more political stuff, so no more CYA

Martha is offline   Reply With Quote
Join the #1 Early Retirement and Financial Independence Forum Today - It's Totally Free!

Are you planning to be financially independent as early as possible so you can live life on your own terms? Discuss successful investing strategies, asset allocation models, tax strategies and other related topics in our online forum community. Our members range from young folks just starting their journey to financial independence, military retirees and even multimillionaires. No matter where you fit in you'll find that Early-Retirement.org is a great community to join. Best of all it's totally FREE!

You are currently viewing our boards as a guest so you have limited access to our community. Please take the time to register and you will gain a lot of great new features including; the ability to participate in discussions, network with our members, see fewer ads, upload photographs, create a retirement blog, send private messages and so much, much more!

Re: More behavioral finance
Old 10-26-2006, 05:09 PM   #2
Thinks s/he gets paid by the post
SecondCor521's Avatar
 
Join Date: Jun 2006
Location: Boise
Posts: 2,401
Re: More behavioral finance

--The pain we get from losing $1000 is greater than the pleasure we get from gaining $1000. This causes many people to shy away from stocks, worrying about the risk. The evolutionary roots may be the importance of retaining territory outweighing any need to gain new territory.


I think this one can also explain market timing sometimes too. I have seen people sell to get out of a market they perceive as high, then watch it drop, then wait until it has gone up a lot before getting back in. They celebrate with joy at avoiding the pain of the loss created by being out of the market when it drops, but I have yet to see an acknowledgement that they also lost real money by not being in for the early part of the runup. For example, the S&P was up quite smartly in 2003, I think, which in my opinion went relatively uncommented upon in the media. I was in for that and enjoyed watching my portfolio go up quite a bit, but there were a lot of people on the sidelines because of 2000-2002 and not really caring that they missed out.

2Cor521
__________________

__________________
"At times the world can seem an unfriendly and sinister place, but believe us when we say there is much more good in it than bad. All you have to do is look hard enough, and what might seem to be a series of unfortunate events, may in fact be the first steps of a journey." Violet Baudelaire.
SecondCor521 is offline   Reply With Quote
Re: More behavioral finance
Old 10-26-2006, 05:09 PM   #3
Recycles dryer sheets
 
Join Date: Oct 2005
Posts: 150
Re: More behavioral finance

Martha - This was a good piece..Behavior and not market returns will be the downfall of the majority of retirement failures over the next 50 years.
__________________
New Thinking is offline   Reply With Quote
Re: More behavioral finance
Old 10-26-2006, 08:26 PM   #4
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
audreyh1's Avatar
 
Join Date: Jan 2006
Location: Rio Grande Valley
Posts: 16,456
Re: More behavioral finance

It is well known that the pain of perceived loss in value of something is far greater than the joy in gain. A recent article about people being unwilling to lower their asking prices on their homes (in spite of the fact that the transaction would result in a net gain - and sometimes a significant net gain) underscored that point. The loss from the (unreasonably) expected value is just too great for some folks.

But honestly I don't see how territory defense has anything to do with it - that doesn't ring true.

I do know there are a lot of folks who hang on to a stock, waiting for it to recover before selling it (if is ever does) - totally ignoring the opportunity cost - the fact that they could likely buy something else today with a better outlook and recover more quickly.

To me this is more about pride and selling something at a perceived loss feels admitting a mistake to many. I sure can't think of an evolutionary advantage to this type of stubborn behavior, but there must have been. Gosh - there must be an evolutionary advantage to unreasonable pride itself! Must have something to do with status in the social group.

Trading has been going on for a very, very long time in human history - long enough to have been shaped by evolution. There must be some clue in there for how it has shaped modern investor psychology. Bragging rights? How long have bragging rights been going on?

Audrey
__________________
Well, I thought I was retired. But it seems that now I'm working as a travel agent instead!
audreyh1 is online now   Reply With Quote
Re: More behavioral finance
Old 10-26-2006, 08:38 PM   #5
Full time employment: Posting here.
 
Join Date: Jun 2006
Posts: 718
Re: More behavioral finance

Too complicated for me. I know I need x amount of funds so when Im x age I can spend the rest of my life doing zip nadda or whatever the heck is in my mind (within my savings )

Maybe Im different. Things dont drive me. But I like to save money and It makes me all tingly when i see it compound and make me more money and then it lump on and compunds again it just oooooo nevermind...
__________________
Mwsinron is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 12:27 AM   #6
Recycles dryer sheets
 
Join Date: Jun 2002
Posts: 374
Re: More behavioral finance

WSJ is free today:

http://tinyurl.com/w8l3x

Cb
__________________
Cb is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 05:14 AM   #7
Full time employment: Posting here.
 
Join Date: Nov 2003
Posts: 926
Re: More behavioral finance

Wow, the only thing I have not done was "hunt for patterns in the stock market." Guess I'm pretty lucky to have ERed, with all of those
old timey gene-embeddded tendencies.

JG
__________________
Some of us have pretty stories, about good friends, good times and noodle salad.
Mr._johngalt is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 09:22 AM   #8
Moderator Emeritus
Nords's Avatar
 
Join Date: Dec 2002
Location: Oahu
Posts: 26,616
Re: More behavioral finance

Quote:
Originally Posted by New Thinking
Martha - This was a good piece..Behavior and not market returns will be the downfall of the majority of retirement failures over the next 50 years.
Yes, all the "new" "old workers" will say that they're back in the cubicles because they're "bored" and "unfulfilled", not "broke".
__________________
*
*

The book written on E-R.org, "The Military Guide to Financial Independence and Retirement", on sale now! For more info see "About Me" in my profile.
I don't spend much time here anymore, so please send me a PM. Thanks.
Nords is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 09:44 AM   #9
Thinks s/he gets paid by the post
MooreBonds's Avatar
 
Join Date: Aug 2004
Location: St. Louis
Posts: 2,091
Re: More behavioral finance

Quote:
Originally Posted by Martha

From Terry Burnham, the author of Mean Markets and Lizard Brains and Robert Frank, the author of Luxury Fever, comes the idea that our instincts are out of step with modern financial life, so we tend to make mistakes, such as:

--we keep striving for bigger houses, fancier cars, bigger paychecks even though research suggests these won’t make us happier in the long run. We do this because our ancestors that survived and reproduced had the greatest drive. There is nothing that tells us to stop as we are "maximizing machines."

--Our ancestors were best served by consuming all they could immediately. Hang on to food? It would rot. Hence the difficulty in saving. “Because saving is such a new concept for us, some folks save too much—and many save way too little.”

--The pain we get from losing $1000 is greater than the pleasure we get from gaining $1000. This causes many people to shy away from stocks, worrying about the risk. The evolutionary roots may be the importance of retaining territory outweighing any need to gain new territory.

--The last point was the need of our ancestors to be good at spotting patterns, like where to fish and get other food. But hunting for patterns can be a disaster in the stock market. If something is too popular, it will be overpriced.

Animal instincts? Maybe, maybe not, but it is fun reading.
I know that there will always be stories about "my great grandmother Mary did this and that" which will disprove one theory or another...but, by and large, isn't the current 65-100 year old generations known for their thriftyness and penchant to save money (often cited because of their experiences of not having it in the Great Depression)?

If that's the case, then how can anyone argue that our 'evolutionary genes' supposedly cause us to spend everything? How could the current retirees go against all those genes to lead them to save up? And how could some societies like China/Japan exist, where the average savings rates are 10-20 TIMES what they are in the US? (2% in the US vs 20-40% over there)?

IMO, it has nothing to do with trend changes in humans - it has everything to do with personality traits and some influence by marketing efforts of corporations and many people caving into peer pressure.

__________________
Dryer sheets Schmyer sheets
MooreBonds is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 09:47 AM   #10
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
dex's Avatar
 
Join Date: Oct 2003
Posts: 5,105
Re: More behavioral finance

Martha,
Thanks for posting this info.

I'm trying to decide right now should I buy a house or wait for prices to fall more. Also, what size house to buy - Large, Med or Small.
__________________
Sometimes death is not as tragic as not knowing how to live. This man knew how to live--and how to make others glad they were living. - Jack Benny at Nat King Cole's funeral
dex is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 10:10 AM   #11
Full time employment: Posting here.
bosco's Avatar
 
Join Date: Jul 2005
Posts: 987
Re: More behavioral finance

anyone read "Fooled by Randomness" by Nassim Nicholas Taleb?

It discusses human behavior and how it hoodwinks us into making unwise investment choices. I found it fascinating.
__________________
I have an inferiority complex, but it's not a very good one.
bosco is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 10:33 AM   #12
Recycles dryer sheets
 
Join Date: Oct 2004
Posts: 214
Re: More behavioral finance

Quote:
Originally Posted by Martha
--we keep striving for bigger houses, fancier cars, bigger paychecks even though research suggests these won’t make us happier in the long run. We do this because our ancestors that survived and reproduced had the greatest drive. There is nothing that tells us to stop as we are "maximizing machines."
Maybe so, though I think there are lots of reasons. At first more and better stuff is a fun way to keep score. Later, after we become disenchanted with the grind it can become a way to reward ourselves for sticking with it. I find that my need for cool stuff has diminised greatly since leaving work. Gone is the need for "comfort spending" to compensate for the negative sensations generated by the workplace. A former passion for collectables has all but dissapeared. On the other hand it might just be finally wising up :
__________________
RockMiner is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 10:41 AM   #13
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
mickeyd's Avatar
 
Join Date: Apr 2004
Location: South Texas~29N/98W
Posts: 5,880
Re: More behavioral finance

Nice link Martha, Thanks.

I always enjoy reading any new information regarding behavioral finance as it's an area of investing that I need to become much more informed about.

"In almost all other settings, it's good or neutral to mimic other people," Mr. Burnham says. "But in the financial markets, it's exactly the wrong thing to do. If something is too popular, it will be overpriced."

Case in point, index funds. I believe that less than 10% of personal investing goes into index funds as most investors want to beat the market and indexing claims to never beat the market. Many long-time investors have tried to beat and re-beat the market for years and finally understand that passive investing beats about 3/4 of the market over the long-term and that is a beautiful thing.

__________________
Part-Owner of Texas

Outside of a dog, a book is man's best friend. Inside of a dog, it's too dark to read. Groucho Marx

In dire need of: faster horses, younger woman, older whiskey, more money.
mickeyd is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 10:56 AM   #14
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
 
Join Date: Jun 2005
Posts: 8,616
Re: More behavioral finance

Quote:
Originally Posted by mickeyd
I always enjoy reading any new information regarding behavioral finance as it's an area of investing that I need to become much more informed about.
An accessible book on behavioral finance is Why Smart People Make Big Money Mistakes Maybe it doesn't have any new stuff for you, but it's a good intro for folks.
__________________
LOL! is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 11:07 AM   #15
Give me a museum and I'll fill it. (Picasso)
Give me a forum ...
mickeyd's Avatar
 
Join Date: Apr 2004
Location: South Texas~29N/98W
Posts: 5,880
Re: More behavioral finance

Quote:
Why Smart People Make Big Money Mistakes
Thanks.
Do you have an author on that LOL?
__________________
Part-Owner of Texas

Outside of a dog, a book is man's best friend. Inside of a dog, it's too dark to read. Groucho Marx

In dire need of: faster horses, younger woman, older whiskey, more money.
mickeyd is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 11:10 AM   #16
Thinks s/he gets paid by the post
ronin's Avatar
 
Join Date: Oct 2003
Posts: 1,190
Re: More behavioral finance

Mean Markets and Lizard Brains is a fun read, not overly deep but hits lots of the biological roots of our behavior. I particularly liked Fooled by Randomness as well, although the author's style/personality is offputting to many.
__________________
We are, as I have said, one equation short. – Keynes
ronin is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 11:30 AM   #17
Moderator Emeritus
Nords's Avatar
 
Join Date: Dec 2002
Location: Oahu
Posts: 26,616
Re: More behavioral finance

Quote:
Originally Posted by LOL!
An accessible book on behavioral finance is Why Smart People Make Big Money Mistakes Maybe it doesn't have any new stuff for you, but it's a good intro for folks.
Quote:
Originally Posted by mickeyd
Thanks. Do you have an author on that LOL?
I'm not LOL, but the book is by Belsky & Gilovich... an excellent read.
__________________
*
*

The book written on E-R.org, "The Military Guide to Financial Independence and Retirement", on sale now! For more info see "About Me" in my profile.
I don't spend much time here anymore, so please send me a PM. Thanks.
Nords is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 01:32 PM   #18
Confused about dryer sheets
 
Join Date: Oct 2006
Posts: 2
Re: More behavioral finance

I have a particular take on Behavioral Finance.... Academic BF claims that there are patterned "errors" and "biases" which "rational" investors can identify and profit from in real-time. Yet there is no hard evidence for this. The examples and studies are all rearward looking after-the-fact. My take is this.... in order to take advantage of my "errors" you - the rational investor - would have to be 100% error-free and fully rational and have perfect objective self-knowledge (contradiction in terms) that this is the case. Kind of a slippery slope.

The low hanging fruit of academic BF is to NOT commit the errors they've identified so well (overconfidence, overtrading, loss aversion, anchoring, etc.)

Now, how do we make money? BF is really about the BehaviorS in marketplace. Long-term buy-and-hold retirees BEHAVE diffently than short-term leveraged proprietary day traders at a bank trading desk. When these behaviors overlap we have big moves and the market quickly becomes non-random. If this is true you should be it able to see it in the frequency distribution of returns.
__________________
acalianos is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 02:38 PM   #19
Moderator Emeritus
Nords's Avatar
 
Join Date: Dec 2002
Location: Oahu
Posts: 26,616
Re: More behavioral finance

[Modified by moderator after poster addressed the original issue.]
__________________
*
*

The book written on E-R.org, "The Military Guide to Financial Independence and Retirement", on sale now! For more info see "About Me" in my profile.
I don't spend much time here anymore, so please send me a PM. Thanks.
Nords is offline   Reply With Quote
Re: More behavioral finance
Old 10-27-2006, 08:18 PM   #20
Recycles dryer sheets
 
Join Date: Apr 2006
Posts: 190
Re: More behavioral finance

Quote:
When these behaviors overlap we have big moves and the market quickly becomes non-random. If this is true you should be it able to see it in the frequency distribution of returns.

I've created an "histogram movie" that shows this. The normal distribution of returns is this tiny little town in Montana that a Masseratti drives through at top speed every now and then.
I believe there was a fellow here that babbled about doing Fast Fourier Transforms of market data waveforms to find frequency distributions of returns. This approach, btw, is:

1) Somewhat more effective than histograms and

2) Not particularly new and has been done before and cannot help one market time because the human components of the market would act a priori on the knowledge

But at least that guy had no spam motivations.
__________________

__________________
modlair is offline   Reply With Quote
Reply


Currently Active Users Viewing This Thread: 1 (0 members and 1 guests)
 
Thread Tools Search this Thread
Search this Thread:

Advanced Search
Display Modes

Posting Rules
You may not post new threads
You may not post replies
You may not post attachments
You may not edit your posts

BB code is On
Smilies are On
[IMG] code is On
HTML code is Off
Trackbacks are Off
Pingbacks are Off
Refbacks are Off


Similar Threads
Thread Thread Starter Forum Replies Last Post
What would you teach in Intro to Personal Finance? Peaceful_Warrior Other topics 18 04-24-2007 12:11 PM
neuroeconomics / behavioral finance LOL! FIRE and Money 1 09-13-2006 11:33 AM
Behavioral Finance mickeyd FIRE and Money 1 02-05-2006 02:10 PM

 

 
All times are GMT -6. The time now is 06:34 AM.
 
Powered by vBulletin® Version 3.8.8 Beta 1
Copyright ©2000 - 2017, vBulletin Solutions, Inc.