INVESTOR PSYCHOLOGY

Created by Erica Abbott USU Family Finance Student

andDr. Jean M. Lown

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Last October’s FPW program is available at www.usu.edu/fpw under past presentations

• Outsmart your brain: Trick your mind to treat your finances– Focused on money management–Watch PPT on YouTube:

http://www.youtube.com/watch?v=B09ff4dZBuc

• Today’s focus: Investor Psychology

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Handout: PF Action Plan

• For your use• Commit to take action• Share your plans with family & friends

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Why do investors earn less than market returns?

• Studies confirm actual investors earn below market returns. Why?

• DALBAR: “average investor earns less - in many cases, much less - than mutual fund performance reports would suggest.”

• Past 15 years: investors in US stock funds earned 2.3% less than the funds themselves (Morningstar report)

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What investors do wrong & why

• React emotionally to $ news• Buy when news is good & prices high• Sell when news is bad & prices low• Jeff Salisbury’s tuna fish analogy– Load up the pantry when canned tuna is on sale– Buy little or none when price is high

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7 Deadly Sins of Investing (Kip. Nov. p. 30)

1. Following the herd2. Giving in to fear3. Hanging on too long4. Neglecting to rebalance5. Making things complicated6. Paying too much in fees7. Failing to stick to the plan

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1. Following the herd

• When an asset class soars… investors pile in– After the price has risen – Buy high (& sell low)– “Past performance is no guarantee of future

returns.”• What to do: “Follow rules, not herds”– Don’t be swayed by CNN, Jim Cramer, etc.– Dollar Cost Average each month on autopilot

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2. Giving in to fear

• 2008-09 financial market meltdown--> avoiding stocks

• Volatility is scary but losses are only on paper until you sell

• Federally insured accounts don’t keep up with inflation & taxes

• Need stocks for long term goals

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Solution: Focus on Long Run

• Since 1926 US stocks (S&P 500) averaged 10%/year (before taxes & inflation)– Lots of volatility along the way but upward trend

• Worst case- Invested @ peak: March 2000– 2 horrendous bear markets– Positive 3.4% annual return

• Stock market is place for long term $

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3. Hanging on too long

We become psychologically invested in what we own… Own a winner? Can‘t part with itOwn a loser? To sell would reinforce the pain

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Redemption

• Have a sell strategy• Review investments yearly• For stocks/funds you own- would you

buy it today? –No? sell part or all–Adopt a target price to sell

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4. Neglecting to Rebalance

Manage risk by diversification &Asset allocationEstablish a % share for each assetcategory based on risk tolerance& time horizon

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Redemption

• It may be counterintuitive but..• Rebalance each year by – Sell some winners and buy some from loser

category, or– Buy only in the loser category

• Forces you to Buy Low & Sell High!

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5. Making things complicated

• Too many different investments• Resembles an index fund but…– At much higher cost

• Redemption: buy index mutual funds or Target retirement date funds– Kiplinger 25 (list of “best” funds)– Money 70 (list of “best” funds)

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6. Paying too much in fees

• One thing you can control: expenses

$10,000 & invest $500/month @ 8%/yr. For 30 yearsIndex fund 0.20%: $818,639Active fund 1.2%: $662,916Difference: ~$156,000

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Redemption

• Compare expense ratios of mutual funds – FINRA fund analyzer http://

apps.finra.org/fundanalyzer/1/fa.aspx• Consider the buy/sell costs of stock trades– Full service broker: $75/trade– Discount broker: $10/trade

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7. Failing to Stick to Your Plan

• Greatest sin: failing to formulate & follow a plan– No plan- how will you know if you are on track? – Specify your goal (SMART) & time line– Having a plan helps you resist the other “sins”

• What are YOUR goals? Time horizon? Plan?

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USING BEHAVIORAL PSYCHOLOGY TO HELP

Behavioral Principles http://www.ideas42.org/category/theory

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Limited Attention

• Can’t text, listen to music & drive… humans are not good at multi-tasking!

• When attention is stretched, people have difficulty focusing on benefits & consequences of options.– Default options (instead of too many choices)– Automatic saving/investing

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Status Quo Bias

• Comfortable & familiar • Change the default through…– Retirement auto enrollment• Few opt out

– Target retirement funds• Diversified, choose year of planned retirement

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Mental Accounting

• Assigning $ to different buckets: rent/mortgage, car payment, etc.

• Plus- prevents spending the rent on dinner out• Minus- using credit increases spending up to 18%

over cash. Such outcomes are difficult to avoid as most credit decisions are ambiguous

• Linking saved money to a particular goal –i.e., college –makes us reluctant to spend the $ for other things

• Take away: 529 UESP College Savings accounts

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Social Norms

• “If everyone else jumped off a bridge…” • Teens aren’t only ones who care about what everyone else is

doing. Knowing what others do provides a reference point against which people can compare options when they are unsure about what to do.

• We misperceive social norms, esp. when some choices are highly visible & others aren’t

• a clearer picture of what constitutes “normal” behavior for peers, friends, neighbors, or citizens can make us more inclined to do same.

• Take away: save 15% of income

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Planning Fallacy

• We underestimate amount of effort & time to complete a task.

• makes it hard to do things like signing up for retirement savings

• Take away: Commit to action & tell friend/spouse/partner/coworker to– Hold your feet to the fire

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Prescriptive & Descriptive Fallacy

• We know what we should do…• Wash hands, offer pregnant women seat, but…• Instead of telling people what they should do,

simply inform people of descriptive norms— what the majority of people actually do.

• R: knowing what other people do is a stronger influence on how they eventually behave than knowing what society says they should do

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Procrastination

• When’s the most popular day of the week to start a diet? Start/increase saving/investing?

• Tomorrow.• The more steps involved, the more likely

someone is to procrastinate.• Too many choices procrastination• Take away: acknowledge & commit

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Self-Control Problems

• At some point even the most disciplined person will succumb to temptation. – We have good intentions, but poor follow-through.

• Especially true where future gain (more financial security) comes at cost of up-front loss (saving instead of spending)

• Take away: retirement withdrawal penalties• CD/I-bond withdrawal penalties

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Choice Overload

• Too many choices can be overwhelming. – People make poor choices or fail to choose– Jam research study

• Get help in choosing!– Enlist the help of knowledgeable person• Retirement accounts- more choices is NOT better• Focus on the basics

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Availability & Representativeness

• Present choices in a way that highlights the important context

• Indicating life expectancy of a population can help people make better decisions about whether they should claim Social Security benefits at age 62 or 67 & prevent people from miscalculating probability that they would not benefit from waiting.

• Take away: You are unique. Estimate your life expectancy w/ online calculators

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Problem: Saving requires attention & self-control

• When $ is tight, mental resources needed to save are stretched thin, too. – Behavioral interventions such as automatic

transfers to savings or reminders about savings goals

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Emotions Get in the Way

• Fear & Greed/exuberance• Fear -> excessive risk aversion• 2008-09 huge outflows from stocks– Market bottomed in March 09 & quickly shot up– Investors who sold locked in their losses & sat on

sidelines while the markets rallied

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5 ‘A’S OF SUCCESSFUL BEHAVIOR CHANGE• Awareness: Realize that you want to change or improve something

• Your Ability to change:• Is this something you can actually control?• Do you need someone else to change with you? i.e. a spouse?

• Ambition: Consider your desire to change • Is it strong? Are you on the fence about it?

• Attitude: Positive? Negative? Back and forth?• “Nothing can stop the man with the right mental attitude from

achieving his goal…” – Thomas Jefferson

• Action: Start implementing the actions that you would need to change certain behaviors

Small Steps to Health & Wealth

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GOAL SETTING• Write your goals down where you will see them• “Goals that are not written down are just

wishes.” -Author Unknown

• Websites send you reminders about your goals• Stickk.com• Mint.com: Sends cell phone reminders when

you go over budget. Plus gives you updates on your goals!

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POWER OF FOCUS

• Focusing on too many things is overwhelming• Paying off debt, savings, retirement,

down payment on a home, etc. Which should come first?

• It might be better to focus on one primary goal at a time

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VISUALLY TRACK YOUR PROGRESS• Helps remind you of your goals

• Seeing progress is motivating• Gets your family involved• Positive peer pressure

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VISUALLY TRACK YOUR PROGRESS

• Use a phone app–Mint.com

• Use a savings thermometer

• Tickers from websites–Tickerfactory.com

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SAVING: FINDING $ TO

INVEST

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• McDonald’s allowed credit card purchases- increased average purchase from $4.50 to $7

• Journal of Experimental Psychology: “Cash discourages spending, and credit or gift cards encourage it…”

• Credit card users spend 12-18% more when using credit instead of cash (Dun & Bradstreet)– Spending increases even more when credit card

offers rewards or cash back

SPEND LESS: PAY WITH CASH

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• “…losing something makes you twice as miserable as gaining the same thing makes you happy.” Nudge by Thaler & Sunstein

• Paying with cash induces a feeling of loss, whereas swiping plastic, only to put it back in your wallet, does not

WHY??

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STRATEGIES FOR ACHIEVING FINANCIAL GOALS

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• Set up automatic deposits to savings, investments, & bill payments

• Once it’s done, you don’t have to think about it anymore!

• Biggest step is making the time to set it up– “Execution”

MAKE IT AUTOMATIC

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Autopilot: Dollar Cost Averaging

• Automatically invest same amount every pay period– Regardless of market gyrations– Removes the emotion & temptation to subvert

your plan– Eliminates the need for willpower

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• Pre-commit to a decision- Consumers are more impatient in the near-

term than in the long term- Seek instant gratification

- Feed the pig next month- But sign up today!

TRICK YOURSELF TO SAVE MORE

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• We’ll commit to saving $100 five weeks from now, but we won’t commit to saving $100 this week. • How to create a good habit:– Sign up to increase (or start) your 401(k)

contributions (emergency savings, power payments, student loans, & credit card payments) starting in a few weeks or months

PRE-COMMIT TO A DECISION

You’re less likely to undo that decision & more likely to start a good habit

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“Unless commitment is made, there are only promises and hopes…but no plans.”

-Peter Drucker

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INCREASE THE COST OF NOT DOING SOMETHING NOW BY

USING

COMMITMENT

CONTRACTS

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Put your mind to it“One of the most powerful motivational strategies to… increase wealth is visualization. People can alter their lives just by altering their mindset. Visualization (a.k.a., mental imagery) is a powerful step in the process of setting and achieving goals.” SSHW What is your vision for your goal?

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Commit to Making a Change (SSHW)

• 5 stages of change (Transtheoretical Model)1. Precontemplation- unaware2. Contemplation- recognize need to change3. Preparation- Commit to make changes4. Action- take the plunge & make changes5. Maintenance- sustain change & reap benefits• Studies show that “plans to change” can predict

actual change.

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• Telling others about your goals & plans helps you stick to them

• Regular reminders from family & friends increases likelihood of success– Self-inflict peer pressure to improve your

financial situation!– Failure to follow through will

result in your anti-charity receivinga donation from you!

– Sign your contract today!!

COMMITMENT CONTRACTS

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www.StickK.com• If you don’t do ‘X’ you’ll have to pay ‘Y’ to

an ANTI-charity of your choice • Recruit a trusted friend as your referee• Use for goals such as paying off debt,

starting retirement, sticking to your budget, weight loss, smoking cessation, etc.

COMMITMENT CONTRACTS

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Resources

• Kiplinger Nov. “How to be a better investor” • Small Steps to Health & Wealth http://

njaes.rutgers.edu/sshw/– Overcoming Obstacles and Taking Action – Behavior Change Strategies– Set a Date and Get Started---Just Do It

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Upcoming FPW • November 13: Estate Planning– Quit procrastinating!– What you need to do & resources to accomplish

• No December program• 2014 topics– Utah’s health policy project- navigating insurance– Financial planner Lon Jeffries– Invest in your house: Upgrades that make sense– Social Security

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Sign up to follow the FPW Blog

• http://www.fpwusu.blogspot.com/• Searchable• Latest info & advice• Answers to your financial questions

QUESTIONS?COMMENTS?

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Curious Behaviors…

• That can ruin your retirement• http://crr.bc.edu/special-projects/interactive-

tools/curious-behaviors-that-can-ruin-your-retirement/