Notes

Behavioral Finance/Economics is a new field, founded by Daniel Kahneman and Amos Tversky; Kahneman won the Nobel Prize for Econ in 2002; Richard Thaler, won Nobel Prize in 2017, for continuing their research.

Example of this study is auto-enrollment in 401k plans. Thaler found that one behavioral bias was to anchor to things how they were. So when participants are auto-enrolled in retirement plans at work, they tend to stay in the plan rather than opt out. It is estimated that this study has helped add over $30 billion to retirement accounts since 2011.

Overconfidence

• Overconfidence has two components: overconfidence in the quality of your information, and your ability to act on said information at the right time for maximum gain. Studies show that overconfident traders trade more frequently and fail to appropriately diversify their portfolio.
• One study analyzed trades from 10,000 clients at a certain discount brokerage firm. The study wanted to ascertain if frequent trading led to higher returns. After backing out tax loss trades and others to meet liquidity needs, the study found that the purchased stocks underperformed the sold stocks by 5% over one year and 8.6% over two years. In other words, the more active the retail investor, the less money they make. This study was repeated numerous times in multiple markets and the results were always the same. The authors concluded that traders are, "basically paying fees to lose money."

Anchoring

• Anchoring bias occurs when people rely too much on pre-existing information or the first information they find when making decisions.
• So if a stock was at $100, then fell to $50, you perceive it as cheap when in reality.

Loss Aversion

• Basic expression is that you feel pain from losses more than you feel pleasure from gains.

Confirmation Bias

• Being drawn to information that validates existing beliefs or opinions. This is often very common with political or religious beliefs, but also exists with financial topics as well.
  • One example is believing the company you work for is the greatest company in the world. For example, if you have worked for Walmart in Arkansas for the last 30 years, you might hold a lot of Walmart stock because you’ve seen the company grow a substantial amount over that time period. But you might have missed out on the gains brought about by tech companies like Amazon who have innovated and taken market share from Walmart simply because you work for Walmart.