Stock Quotes

In a previous article “Are Your Emotions Costing You Money,” I examined traditional and behavioral finance theories, and identified several biases that interfere with investors’ ability to make sound investment decisions. In this article we delve deeper into each of the biases, and explore simple, yet effective ways to overcome those biases. While there are a multitude of behavioral biases, this article will focus on three: mental accounting, anchoring, and overconfidence.

Mental Accounting – is the process whereby investors categorize their assets into separate mental “buckets”, and thus spend or allocate funds differently. Some examples: Susan receives a monetary gift for her birthday and uses it to go out for a gourmet dinner; Bill allocates his year-end bonus for Christmas presents; upon receiving his tax refund, Sam takes a vacation he hadn’t built in to his regular budget.

Research corroborates these examples; people do tend to spend their tax refunds differently than they spend their normal wages. Interestingly, in the past several years surveys show that Americans are spending their tax refunds to pay down debt in an effort to deleverage their household balance sheets. When investors practice mental accounting such as those in the examples above, they tend to view and assess individual assets separately instead of as a part of a total portfolio.

Anchoring – is when an investor latches on to the first bit of information they receive and is unwilling to accept new information. Assume John purchased a home for $500,000 at the peak of the market and is now trying to sell his home in a depressed real estate market; he would be reluctant to list or sell his home for less than $500,000 because he is emotionally anchored to that “value” for his home. When investors exhibit the anchoring bias, they are unwilling to accept new information that is contrary to their the view that his home is worth $500,000 when it fact it might be worth much less. The risk here is that because John is anchored to his price, he may not be able to sell his home in a timely manner, which in-turn may have detrimental affects on his finances and portfolio, not to mention the possibility that the home value could decrease even further.

Overconfidence – Investors who are overconfident overestimate their ability to analyze data. Suppose Jane made some money on Cisco stock, she would begin to believe that she has a keen ability to identify all upward trending technology stocks. As a result, Jane would begin to buy more and more technology stocks, and thus her portfolio would become less diversified – diversification is one of the cornerstones of a balanced portfolio. Additionally, investors who are overconfident tend to not only have more concentrated portfolios, but also trade more frequently because they have an illusion of control that they can sell or buy at the “right time”. Many investors who exhibited the overconfidence bias during the dot-com era and the subsequent real estate boom, found themselves to be overexposed when that sector had a sharp reversal, and as a result lost most of their assets and wealth.

Overcoming Biases

As you have read, an investor’s emotions can have detrimental effects not only on his/her portfolio, but also on stress level. The good news is that there are ways to significantly reduce these effects. Here are five things you can do right now to avoid some common behavioral biases.

1. Stop watching the daily news. News networks draw ratings by evoking viewer emotions; TV is meant to incite not inform. Watching news every day causes investors to react emotionally, rather than analytically and strategically.

2. Don’t look at your portfolio everyday. Investors who check their portfolios every day tend to trade more frequently and take on more risk.

3. Don’t fall subject to the anchoring trap. Read contradictory news. Actively seek news stories that differ from your viewpoint, and give them equal weight.

4. When evaluating investments, don’t just look at the risk and return characteristics of that individual investment. Rather, analyze how that particular investment will impact your total portfolio, and determine whether it will enhance your total return, minimize risk, or both.

5. Lastly, work with a Fee-Only financial advisor to develop a sound financial plan that is specific to your needs. Remember that investing is a long term endeavor, so stick to that plan!

Behavioral finance is a relatively new field of study and academics are continuously researching new relationships between investor emotions and their finances. While financial experts have identified a multitude of investor biases, the three detailed above have the most acute consequences, and yet can be overcome when investors are willing to slightly change their habits.

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1. Know before you go. Information is valuable. You would do well to learn about the area of investing in which you have interest. The library, the bookstore and the internet are good resources for gaining knowledge. A basic understanding of how things work will allow you to take your first steps with a greater degree of comfort.
2. Understand the process. Everything has a beginning, a middle and an end. What are the practical circumstances that may affect your risk and your value? How do they occur and when? Try to avoid following others blindly. Their situation may not be the same as yours. It is better to rely on your own knowledge and to build your experience level.
3. Read the prospectus. An investment fund has a prospectus which describes not only the objective of the fund but also the portfolio, the fees and charges incurred, the management, the nature of the risk, the valuation process, and how you put your money in and take your money out. There is an ongoing effort to make prospectuses easier for the public to read. Take some time to cover the basics.
4. Ask questions. Someone besides you has asked the same questions before. The investment company, the broker, the regulatory organization or an informed third party knows the answer. Follow up on your concerns until you are satisfied.
5. Start small. You are more likely to make mistakes in the first part of your learning curve. Keep your investments small. You will pay a lower price for the cost of learning. Investing is not a guaranteed activity. Seasoned investors lose money–usually because of a risk taken rather than because they lack knowledge. Informed risk-taking is better than uninformed risk-taking. Small losses are better than big losses.
6. Start simple. There are many investments and strategies that are complicated. Invest in what you understand. It is not enough that someone has explained how things work. You should understand the investment completely. “I didn’t realize that could happen,” is not a pleasant admission for an investor.
7. Choose a suitable investment. What is your tolerance for risk? Everyone has their own answer. Determine your comfort zone and make sure that the investment choice matches. A good investment is one that you can stay with over a longer period of time.
8. Set a goal. How much is enough? What is reasonable? Ask yourself what you want from your investment and what is your time frame. Periodically assess your progress toward the goal. Are you on track or should you change your expectations? Further research may help you answer these questions.
9. Assume responsibility. When you invest your money, you are responsible for what happens. Someone else may have given you information or advice but, in the end, the results are yours. Taking ownership of your choices heightens your level of interest and understanding. You also gain useful experience.
10. Admit errors and make changes. Sometimes impulse prevails over reason or you make a wrong choice. A small mistake is better than a big mistake. Be honest with yourself and take action.
11. Follow your own advice, avoid the herd. The herd mentality doesn’t take your situation into account. Examine your investment choices from your own vantage point:–what is good for you.
12. Become your own expert. Information or advice from others is often incomplete or misleading. Do your own research and assessment. Develop your own reasons for making choices. When it comes to your money, you will take the best care.

Howard Feigenbaum is Registered Principal and Owner of Sharemaster, a Broker-Dealer firm that specializes in monthly dividend income funds.

“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.” – John D. Rockefeller

http://www.monthlydividendcheck.com/

If you’re investing in Cash, do you still need to learn about stock quotes? Oh, absolutely, because guess where the cash you invested in your bank goes? That’s right to companies actively traded on the market’s Big Board!