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Portfolio
              Perspectives
                August 2012




Understanding the Emotions of Investing
                                                                              University and member of the Loring Ward Investment Com-
                                                                              mittee, said this about confirmation bias: “Investors who believe
                  By Joni Clark, CFA, CFP®                                    that they can pick winning stocks are regularly oblivious to their
                  Chief Investment Officer, Loring Ward                       losing record, recording wins as evidence confirming their stock-pick-
                                                                              ing skills but neglecting to record losses as disconfirming evidence.”
                                                                              Hindsight Bias is the belief that a past event was more predict-
“The investor’s chief problem — and even his worst enemy — is likely          able than when the event took place, or “I knew it all along.”
to be himself.”                                                               Sports fans know this as “Monday Morning Quarterbacking,”
             — Benjamin Graham, The Intelligent Investor, 1949                as it is always easy on Monday to see exactly what decisions the
                                                                              football coach should have made in Sunday’s game. From an
Why do so many investors make decisions based upon emotional
                                                                              investing standpoint, this bias can lead investors to be overly
reactions to short-term events?
                                                                              confident that they possess superior investing abilities.
One possible answer: Because we’re human. It’s normal to feel
                                                                          Many investors today are fatigued by the endless gloomy news and
anxiety during economic downturns or market turmoil, but acting
                                                                          market volatility — and as a result they succumb to these emo-
upon those anxieties can lead to imprudent investment decisions.
                                                                          tional biases that prevent them from sticking to a well-thought-out
The key is finding the balance between emotion and reason.
                                                                          investment plan.
An emerging field of science known as behavioral finance attempts
                                                                          It is important to recognize that any investment, no matter how
to answer the questions of how psychology impacts our decisions
                                                                          conservative, is subject to risks, and that some investors may find
about money and has attracted significant attention in the academic
                                                                          themselves substituting one form of risk for another.
community. The Nobel Prize in Economics in 2002 was awarded
to Daniel Kahneman for his work in this field. Some of the research       Stuffing cash in your mattress, for instance, may seem pretty
in behavioral finance deals with cognitive errors or biases that all of   prudent, but you’re out of luck if your house burns to the ground.
us tend to make, especially in times of stress. Here are a couple of      Money market funds have provided a measure of stability, but will
examples, specifically noting how they apply to investing:                generally fail to keep pace with inflation, meaning that you may
                                                                          need to decrease your spending so your money can last throughout
    Confirmation Bias refers to the tendency of people to look
                                                                          your retirement. Likewise, some pundits tout gold as a safe com-
    for information that attempts to support their beliefs. Meir
                                                                          modity, but gold and all other precious metals have experienced
    Statman, Glenn Klimek Professor of Finance at Santa Clara
                                                                          dramatic price fluctuations throughout history.
Portfolio Perspectives

Achieving your long-term financial goals means accepting the                  financial decisions, the more likely we are to be able to balance
trade-off between risk and return of different investment asset               those emotions with reason.
classes, and combining those asset classes to manage risk through             Our continued message of “stay the course” and “tune out the
diversification.                                                              noise” may feel boring or outdated, but may be an appropriate
When the markets are unsteady, investing requires discipline and              choice for long-term investors with a prudent, diversified invest-
patience in order to overcome our emotional tendencies. It’s                  ment portfolio.
certainly easy to give in to the temptation to make major changes             An asset class investing philosophy isn’t flashy, and it’s not always
to your asset allocation every time the market slumps or soars.               popular in some quarters, but it has helped many investors over the
Likewise, it’s tough to stand firm when the herd is stampeding this           long haul. We strongly believe it will remain an appropriate choice
way and that, chasing after the latest hot fad. The more we can               well into the future.
learn about how our emotions can get in the way of making wise




Implementing an Asset Class Investing strategy cannot guarantee a gain or protect against a loss.
Past performance does not guarantee future results and the principal value of an investment will fluctuate so that an investor’s shares, when
redeemed, may be worth more or less than their original cost. Stock investing involves risks, including increased volatility (up and down move-
ment in the value of your assets) and loss of principal.

© 2012 LWI Financial Inc. All rights reserved. LWI Financial Inc. (“Loring Ward”) is an investment adviser registered with the Securities and Exchange
Commission. Securities transactions may be offered through Loring Ward Securities Inc., an affiliate, member FINRA/SIPC. 12-361 (Exp 8/14)

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  • 1. Portfolio Perspectives August 2012 Understanding the Emotions of Investing University and member of the Loring Ward Investment Com- mittee, said this about confirmation bias: “Investors who believe By Joni Clark, CFA, CFP® that they can pick winning stocks are regularly oblivious to their Chief Investment Officer, Loring Ward losing record, recording wins as evidence confirming their stock-pick- ing skills but neglecting to record losses as disconfirming evidence.” Hindsight Bias is the belief that a past event was more predict- “The investor’s chief problem — and even his worst enemy — is likely able than when the event took place, or “I knew it all along.” to be himself.” Sports fans know this as “Monday Morning Quarterbacking,” — Benjamin Graham, The Intelligent Investor, 1949 as it is always easy on Monday to see exactly what decisions the football coach should have made in Sunday’s game. From an Why do so many investors make decisions based upon emotional investing standpoint, this bias can lead investors to be overly reactions to short-term events? confident that they possess superior investing abilities. One possible answer: Because we’re human. It’s normal to feel Many investors today are fatigued by the endless gloomy news and anxiety during economic downturns or market turmoil, but acting market volatility — and as a result they succumb to these emo- upon those anxieties can lead to imprudent investment decisions. tional biases that prevent them from sticking to a well-thought-out The key is finding the balance between emotion and reason. investment plan. An emerging field of science known as behavioral finance attempts It is important to recognize that any investment, no matter how to answer the questions of how psychology impacts our decisions conservative, is subject to risks, and that some investors may find about money and has attracted significant attention in the academic themselves substituting one form of risk for another. community. The Nobel Prize in Economics in 2002 was awarded to Daniel Kahneman for his work in this field. Some of the research Stuffing cash in your mattress, for instance, may seem pretty in behavioral finance deals with cognitive errors or biases that all of prudent, but you’re out of luck if your house burns to the ground. us tend to make, especially in times of stress. Here are a couple of Money market funds have provided a measure of stability, but will examples, specifically noting how they apply to investing: generally fail to keep pace with inflation, meaning that you may need to decrease your spending so your money can last throughout Confirmation Bias refers to the tendency of people to look your retirement. Likewise, some pundits tout gold as a safe com- for information that attempts to support their beliefs. Meir modity, but gold and all other precious metals have experienced Statman, Glenn Klimek Professor of Finance at Santa Clara dramatic price fluctuations throughout history.
  • 2. Portfolio Perspectives Achieving your long-term financial goals means accepting the financial decisions, the more likely we are to be able to balance trade-off between risk and return of different investment asset those emotions with reason. classes, and combining those asset classes to manage risk through Our continued message of “stay the course” and “tune out the diversification. noise” may feel boring or outdated, but may be an appropriate When the markets are unsteady, investing requires discipline and choice for long-term investors with a prudent, diversified invest- patience in order to overcome our emotional tendencies. It’s ment portfolio. certainly easy to give in to the temptation to make major changes An asset class investing philosophy isn’t flashy, and it’s not always to your asset allocation every time the market slumps or soars. popular in some quarters, but it has helped many investors over the Likewise, it’s tough to stand firm when the herd is stampeding this long haul. We strongly believe it will remain an appropriate choice way and that, chasing after the latest hot fad. The more we can well into the future. learn about how our emotions can get in the way of making wise Implementing an Asset Class Investing strategy cannot guarantee a gain or protect against a loss. Past performance does not guarantee future results and the principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Stock investing involves risks, including increased volatility (up and down move- ment in the value of your assets) and loss of principal. © 2012 LWI Financial Inc. All rights reserved. LWI Financial Inc. (“Loring Ward”) is an investment adviser registered with the Securities and Exchange Commission. Securities transactions may be offered through Loring Ward Securities Inc., an affiliate, member FINRA/SIPC. 12-361 (Exp 8/14)