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Common investment mistakes


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Common investment mistakes

  1. 1. Common Investment Mistakes “The Psychology of Poor Investment Decisions and Active Trading” Presented by: Gerry O. Gatawa Saint Louis University Baguio City, Philippines
  2. 2. What investment is right for you?
  3. 3. What type of investor are you? Some investors listen to RUMORS/ GOSSIPS
  4. 4. Why Do Prices Fluctuate?
  5. 5. MARKET PSYCHOLOGY Each investors would have his or her own opinion about a certain security.
  6. 6. The Psychology of Poor Investment Decisions
  7. 7. Rationale of Investment Biases • Activity #1 – You go to the grocery store and you need to purchase paper towels. • You find they are on sale at 10% below their normal price. – What do you do? • You buy a case of paper towels because you know this is a good price • Activity #2 – You invest in the stock market. You own 100 shares of San Miguel Corporation stock • More news comes out, and San Miguel Corporation stock drops 20%. – What do you do? • Instead of buying more, like the paper towels, you immediately think about selling the stock – Likewise, if the stock starts to appreciate in value, you think to buy more, rather than sell
  8. 8. Overconfidence and Over-optimism • Investors overestimate their ability and the accuracy of the information they have. • Example: KUYA J owners lead Pacifica Takeover Newspaper: Philippine Daily Inquirer (2017, January 10) “…Kuya J took over the board and management of a dormant mining firm…instead of having an IPO for public listing, PACIFICA was used for backdoor listing of the fast growing restaurant in the country…”
  9. 9. PA: Pacifica Inc. Source: The Wall Street Journal (2017). Accessed from March15, 2017 Opening Price 0.068 Decision: Are you going to buy more or sell? February 6, 2017 Opening Price 0.044 News: Confirmed Decision: Are you going to buy considering the News? January 10, 2017 Opening Price 0.045 Decision: Are you going to buy considering the News?
  10. 10. Representativeness • Investors assess situations based on superficial characteristics rather than underlying probabilities.
  11. 11. BSC:PH Basic Energy Corporation News: Basic Energy Corp. is set to start drilling a geothermal well in Batangas province in the first half, a company official said. Rumor: Result will come out end of 1st quarter, result seems to be positive Source: Manila Standard (2016, January 5)
  12. 12. Conservatism • Forecasters cling to prior beliefs in the face of new information.
  13. 13. FNI: PH Global Ferronickel Holdings Inc • Business News: Global Ferronickel, Chinese firm tie up for $700-M steel plant in the Philippines • Source: Philstar Global (2016, October 24) Investors cling to prior belief despite of decrease in price and closure of mining firms under Secretary Gina Lopez.
  14. 14. Availability Bias • Investors overstate the probabilities of recently observed or experienced events because the memory is fresh.
  15. 15. WEB:PH Philweb Corporation • Duterte ordered its closure calling Roberto Ongpin as oligarch
  16. 16. Anchoring and Frame Dependence • The form of presentation of information can affect the decision made. • Perception and memory are influenced by context, or the frame. • The frame that a decision maker adopts is controlled partly by the formulation of the problem and partly by the norms, habits, and personal characteristics of the decision maker. • People generally evaluate acts based on the direct consequences of the act, such as the money lost or gained. • People adopt mental accounts due to this mode of framing: (1) simplifies evaluation and reduces cognitive strain; (2) reflects the intuition that consequences should be causally linked to acts; (3) matches the properties of hedonic experience, which is more sensitive to desirable and undesirable changes than to steady states.
  17. 17. Anchoring and Frame Dependence (example) Example 1: A sweater is currently priced as Php. 500 and another sweater is on sale for Php. 500 which is regularly priced at Php. 750. Which would you buy?
  18. 18. TEL:PH Philippine Long Distance Corporation PLDT’s price declined due to PSEi and S&P 500
  19. 19. Mental Accounting • Individuals allocate wealth to separate mental compartments and ignore correlation effects. • Example: • Assume you are given an investment with a return of 10% per annum that is guaranteed and analysts suggest that it is a good investment. How much would be the maximum amount you would be willing to invest given your cash is distributed as follows? Nature Amount Cash 250,000 Ordinary Savings (2% per annum) 250,000 Precautionary or Emergency Fund (0%) 250,000 Educational Fund (for family or children) 250,000
  20. 20. Regret Aversion • Individuals make decisions in a way that allows them to avoid feeling emotional pain in the event of an adverse outcome.
  21. 21. DNA: PHILAB Holdings Corporation • Because of experienced long emotional pain, there is already a feeling regret aversion.
  22. 22. Prospect Theory • Individual investors are both risk-seekers and risk averters at the same time. This is exhibited by their investing behavior, where they buy not only bonds, mutual funds, and insurance policies (acting as if they are risk averse), but also where they buy individual stocks, options, and lotteries (acting as if they are risk seeking). • Both professionals and individuals sell winners too early and hold losers too long, attributed to “loss aversion” behavior. Losses cause more severe pains (almost twice as much) than pleasure resulting from a gain of the same magnitude. This is also known as “disposition effect.” • Prospect’s theory’s loss aversion also explains why equities have outperformed bonds.
  23. 23. Prospect Theory (Disposition Effect)
  24. 24. EDC:PH Energy Development Corporation Sell Hold
  25. 25. Heuristics and Biases Framework • They are information processing shortcuts that mainly result from one’s experiences in a field of work. By nature, heuristics are imperfect and consequently will result in biases and errors.
  26. 26. Heuristics and Biases (Example) Answer the questions so you are 90% sure the answer is between your minimum and maximum guess. You can guess any number or range, but you must be 90% sure you are right. • 1. What is the average weight of an adult blue whale in pounds? • 2. What year was the Mona Lisa was painted? • 3. What is the number of independent countries in the world in the year 2000? • 4. How many bones are in the human body? • 5. How many total combatants were killed in WW1 from all sides? • 6. How fast does the earth spin at the equator in miles per hour?
  27. 27. Answers Take note that you were 90% sure. • 1.Weight of adult blue whale: – 250,000 pounds • 2. Year the Mona Lisa was painted: – 1513 • 3. Independent countries in the world in 2000: – 191 • 4. Number of bones in the human body: – 206 • 5. Combatants killed in WW1: – 8.3 million • 6. Speed of the earth at the equator (how fast does it spin): – 1,044 mph
  28. 28. Cooperation and Altruism • Cooperation may be viable investment strategy. • People’s motives may lead to actions different than conventional rationality. • What to do?  Think about other alternatives, other perspectives on investing.  Learn to think “outside the box”
  29. 29. Bidding and the Winner’s Curse • Bidding may lead to a suboptimal result when you bid your fair value. • Assuming everyone else has the correct value, if you won you overpaid! • What to do?  Be careful in setting you bid prices  Generally, don’t bid your fair value—bid lower.  Don’t get emotional in your bid prices for financial assets. You don’t have to buy it at this price.
  30. 30. Endowment Effect • Sometimes we perceive that an asset’s value increases by virtue of our ownership. • Once you own something, its value hasn’t increased or changed. • What to do?  Realize that just because you own something does not increase the value of the asset.  Do not get too emotionally attached to a financial or other asset that you own.
  31. 31. Status Quo Bias • Sometimes individuals prefer the status quo over a new, more preferable position • There is an aversion to change, even if the change is for the better • Change may actually be good. • What to do?  Try to be open minded with new ideas  Be open to new ideas as long as they follow the principles of successful investing and your investment plan that you put together
  32. 32. Loss Aversion • Often losses are given more weight in our minds that potential gains in any position. • These weights are more than utility theory would suggest • What to do?  Give gains and losses equal weight in you analysis  It is gains and losses of the overall portfolio that are important, not individual securities.
  33. 33. Mental Accounts • Often investors keep mental accounts rather than viewing individual assets as part of a total portfolio • We try to save ourselves from ourselves • We borrow 12% for a car versus taking the money from our investment account for the kids college savings (which are earning 2% annually) • We know we may not pay it back if we do not borrow from the bank. • What to do?  Set up separate accounts for each separate goals
  34. 34. Winning by Losing • Sometimes we actively trade stock instead of buying ETFs which we know are lower cost and take a lot less time to invest • We know index funds generally outperform the actively managed funds • And we do not have time, energy, or the money to try to beat the market • What to do?  If you do not have the time, energy, and money, invest in “sleep-well” portfolios of index funds.  You will at least get market returns and will generally beat most actively managed funds
  35. 35. Seeking Solace (Abdicating Responsibility) • Sometimes we follow newspaper/ newsletter advice which we know has been shown to under-perform. • We prefer to take other’s advice rather than doing our own homework. • If the performance goes bad, we can blame others (we don’t have to take responsibility) • What to do?  Realize the limitations of these recommendations  If you have no better knowledge, invest in index funds/ ETFs/ Mutual Fund which are possibly managed.
  36. 36. VITA: PH Vitarich Corporation • News: Vitarich is making a big comeback in agribusiness Paid their debt and infused fund on working capital Corporate rehabilitation is done • News Source: ABS-CBN (2016, September 19)
  37. 37. Fun • Sometimes we trade for fun and entertainment instead of financial performance • This is OK, but make sure your fun money is no more than 5% of the value of your portfolio—that way you don’t lose too much • What to do?  If you want “fun” money, set up a trading account in a retirement vehicle (so you don’t have to pay taxes until later).  Trade until the money is gone—then stop
  38. 38. Overreaction • Many investors assign a probability to asset returns based on past theory • Appropriate reaction to negative event is to update to the most recent event • Overreaction happens when investors assign a high value on a financial investment • What to do?  Stay diversified, true to your Investment Plan and don’t invest on rumors  Invest for the long-term, not on rumors
  39. 39. Mean Reversion • Prices tend to correct themselves as investors correct for overreaction • Long-term prices tend to revert to the mean • What to do?  Realize that the best performing stock or mutual fund last year will not be the best performer this year.  Winners revert to average performers over time  Don’t buy last year’s best performers  Invest for the future—not from the past
  40. 40. Active Trading • The buying and selling of securities with the intention of holding the securities for a short duration, typically for no more that one day. • It is an investment strategy that seeks to take advantage of short-term movements in price, and often focuses on financial instruments in higher demand such as stocks, currencies, options, and derivatives. • Active trading is considered one of the most speculative trading strategies. • Worst, some quit their jobs to be professional traders. Many of them were headed for disaster!
  41. 41. Morning activity 6:00 – 7:00: Read business news. 8:00 – 9:00: Check stock prices 9:00 — 9:15 Contact your broker
  42. 42. Start of trading day Buy shares and wait.
  43. 43. “Patience is a Virtue” • I was so sad when I only gained Php. 15,000 for 1 hour. • Wait until 11:30 before selling
  44. 44. The Psychology of Investment Scam
  45. 45. Examples • Old 1 Peso Coin scams • Tuko Gecko Scam • Text Scams “You won 1 million pesos” • Ponzi Scheme “promising high returns” • Pyramiding scam “recruitment” • and a lot…
  46. 46. Lessons from Successful Investors • Warren Buffet A Famous American investor know as “the Oracle of Omaha” for his market foresight and oracular pronouncements on value investing. He is the Chairman of Berkshire Hathaway (BRK.A) a holding company for a diverse set of businesses, which he developed from an unprofitable textile manufacturing operation. His wealth fluctuates with the performance of the market, but for the past decade he has been consistently ranked as one of the world’s richest men. Lessons from Warren Buffet:  Reinvest your profits  Be willing to be different  Never suck your thumb—unnecessary sitting and thinking  Spell out the deal before you start  Watch small expenses  Limit what you borrow  Be persistent  Know when to quit  Assess the risk  Know what success really means
  47. 47. Lessons from Successful Investors • PETER LYNCH An accomplished Wall Street stock investor, is often said to be one of the best stock-pickers in the world. At present, he is a research consultant at Fidelity Investments. Lessons from Bob Farrell:  Only buy what you understand  Always do your homework  Invest for the long run
  48. 48. The Intelligent Investor Know the business Know who runs the business Invest for profit Have confidence
  49. 49. List of Investment Rules • To be consistently profitable • To be disciplined • To focus on opportunities • To catch market breakouts and take all my signals • To have control over my investments • To have a high level of self-esteem when I trade • To have more confidence in myself after taking a loss or experiencing a drawdown in my account • To have a better understanding of my emotions when I trade • To develop an approach that I can trust and apply effortlessly • To define my losses and not dwell on them • To trade from the perspective that trading is a process and not merely a series of independent trades • To establish limited risk and limitless profit potential • To become a better investor by constantly learning more about myself • To operate completely in the here and now
  50. 50. Money Toss Empty the change from your pocket or wallet every night and throw it into a jar. At the end of each month, deposit all you “throwaway” money in your savings account. That loose change can really add up.
  51. 51. Money Toss Your financial life is like a garden. If you tend a garden carefully, nourishing the flowers, pruning, and weeding, it’s going to be a lot more beautiful than if you just water half- heartedly now and then
  52. 52. Money Toss Lack of contentment— which really comes down to greed—sows the seed of envy and aggressive competitiveness, and leads to a culture of excessive materialism. The negative atmosphere this becomes the context of all kinds of social ills which brings sufferings to all.
  53. 53. Money Toss “The only person responsible in taking care of you when you retire should be the strong person you are now”
  54. 54. Money Toss “The investor’s chief problem, and even his worst enemy, is likely to be himself”
  55. 55. Money Toss “There are three factors that influence the market—Fear, Greed, and Greed”
  56. 56. Money Toss “Why do we need to make a financial plan? Because it is easier to spend than to save”
  57. 57. Money Toss He who does not change his mind is like stagnant water, he breeds REPTILES of the mind.
  58. 58. Money Toss Money is the best servant but the worst employer. Make money your servant and not your employer.
  59. 59. Money Toss There are two rules in the Stock Market: Rule#1: Don’t lose money Rule#2: Refer to Rule#1
  60. 60. Final Remarks Your future depends on YOU not your employer. Manage your finances well and INVEST WISELY
  61. 61. Bibliographies Bernartzi, S. (2012). Behavioral Finance in Action: Psychological challenges in the financial advisor/client relationship, and strategies to solve them. Global Alliance Investor Byrne, A. and Brooks, M. (2008).Behavioral Finance: Theories and Evidence.The Research Foundation of CFA Institute Byrne, A. and Utkus, S. (2013). Behavioral Finance: Understanding how the mind can help or hinder investment success.UK: Vanguard Asset Management Ilia D. Dichev, “What Are Stock Investors’ Actual Historical Returns?” The American Economic Review, vol 97, no. 1, pp 386 – 401 (2007). A. Edmans et al., “Sports Sentiment and Stock Returns,” Journal of Finance, vol 62, pp 1967 - 1998 (2007). John Galbraith, A Short History of Financial Euphoria, Whittle Books in association with Viking, New York, 1993. Xavier Giné et al., “Put Your Money Where Your Butt Is: A commitment savings account for smoking cessation,” American Economics Journal, vol 2, no. 4, pp 213 – 235 (2010). David Hirshleifer and Tyler Shumway, “Good Day Sunshine: Stock returns and the weather,” The Journal of Finance, Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decisions Under Risk,” Econometrica, vol 47, no. 2, pp 263 – 291 (1979). Investopedia