Emotional Biases found in the investors .

1. Emotional Biases of Investors
 By M.Yasodhai

2. Can Binjing be the next
Warren Buffet??
Lets see …

3. Mr.Binjing:
 A highly ambitious man 45 yr IT professional, survived by his wife and 2
boys
 Recently, he was rewarded bonus and modest hike in his salary .
 Since then he bought a 5 bed room flat ,a sudden jump from a 2 bedroom
flat with a huge EMI per month which leaves no room for saving.
 His two children will enter into college in 4 years time,he assumes by that
time he will get a salary hike and a similiar bonus too.
…..is he emotionally biased

4. Examples of lack of self control:
 Enrollment in Gym and never turning up…
 Obese people fail to cut back on food consumption…
 Smokers continue to smoke even though aware of long term health
risks…
 When ample of things to be done ,but still wasting time in FB
,whatsapp etc…
 People may know they need to save for retirement, but they have
difficulty sacrificing present consumption because of a lack of self
control on current spending …
From Behavioral Finance jargon he has be diagnosed with ….
Self control Bias : He has a strong desire to consume today, which
can be counterproductive to attain his long term financial goal.

5. Despite a net worth measured in $$$billions, Warren Buffett
earns a base salary of $100,000 a year at Berkshire
Hathaway. It's a salary that has not changed in 25 years. A
man of simple tastes, Buffett easily supports his modest
standard of living with this salary. He lives in the same five-
bedroom house in Omaha that he bought in 1958 for
$31,500.
….this is Mr.Buffett

6. Emotions in advertisements….

7. Other habits of Binjing…..
 His favorite pastime is stock investment, calls himself as a long term
investor like Mr.Buffett .
 he watches his portfolio of stocks daily and keeps readujsting according
to the latest hot recommendation available on TV ,but then
 At times, his positions shows below his cost price but still waits for his
shares to breakeven ,even if he knows that some of the companies which
he holds is experiencing permanent difficulties ,he assures himself that
miracle happens everyday and some day those companies will be hale and
healthy.
Now What….

8. ....he has been diagnosed with
 Loss aversion Bias: The pain of loss is far greater than the enjoyment of a gain.
 Holding loss positon longer than justified by fundamental analysis and selling winner
too quickly .
 makes investors unduly conservative eg: holding 30 to 40% in bonds where the time
horizon is deacades
 Sitting on huge losses and not admitting making mistake on stock selection ,but if
don’t sell a mistake ,you are potentially giving up a gain that could be earned by
reinvesting smartly.
 Regret Aversion (Herding Behaviour): to avoid regretting latter they buy the
popular opinion and tell themselves they are not to blame if others are wrong too.

9. What Buffett has to say….
 He says …..Investors don’t need “extraordinary intelligence”, but they do need to
be able to watch their holdings halve in value without becoming panic-stricken, if
the holdings has sound fundamental analysis.
 When stock markets crashed on Black Monday in 1987, Berkshire’s share price
suffered its biggest-ever one-day fall, plunging 18 per cent and denting Buffett’s
fortune by an estimated $347 million.
 Buffett shrugs off these paper losses; in his 1987 annual letter, he did not even refer
to Black Monday. This approach has served him well, with Berkshire’s share price
soaring from $2,675 in 1987 to last December’s all-time high of $229,000.

10. Any other biases??
 His friend who works for a Bio tech firm
 sometime back told him about his firms breakthrough in a new technology
which is in a development stage and very much confident of its success
 Binjing assumes his friend must have vast knowledge of his company since he
is a long term employee and buys the shares of this firm without a second
thought.
 Also , Binjing believe he has a superior ability to beat the market most of the
time ….
Yet again, Binjing has been possessing ….
 Over confidence bias: He thinks his friend knows everything about the
current situation of that Bio tech company and he fallaciously equate the
quantity with quality of information .He is underestimating risks involved and
overestimate expected returns.
 Beleiving they can pick stocks that will deliver superior future performance
without any supporting evidence ….

11. This is Warren Buffett…
 Buffett adamantly restricts himself to his "circle of competence" -
businesses he can understand and analyze.
 As Hagstrom writes, investment success is not a matter of how much
you know but rather how realistically you define what you don't
know.
 Buffett considers this deep understanding of the operating
business to be a prerequisite for a viable forecast of future business
performance. After all, if you don't understand the business, how can
you project performance?
 Buffett's business tenets each support the goal of producing a robust
projection. First, analyze the business, not the market or the
economy or investor sentiment. Next, look for a consistent operating
history.
 Finally, use that data to ascertain whether the business has favorable
long-term prospects.

12. what can be done ……
 Perform post-investment analysis on both successful and unsuccessful
investment.
 Was the investment bought at a particular advantageous time based
on fundamentals or was a luck during market upswing.
 Errors made during time to sell or was the market going through a
correction.
 During unprofitable decisions, look for common mistakes which the
person was unaware of making

13. OMG!!! Binjing possess Endowment bias too…..
 He inherited large number of securities when his Uncle died 5 years back
 Now the company crossed its high speed of growth and in declining phase
and some gossips about the management involvement in fraudulent
activities so the share prices now only represent 8 times its cost price and 2
years back shares touched its life time high ( i.e almost 20 times the cost
price ) .
 He is still reluctant to sell his shares because he fear that the position will
increase in value someday and may regret having sold it.

14. Endowment Bias:
 Where people value an asset more when they hold rights to it than
they do not.
 Binjing must know the purpose of the holding the inherited security
,was that on the basis of fundamental analysis or being emotional
with the security. When financial goal are in jeopardy ,emotional
attachment must be moderated.
 Buffett contends that the key to overcoming emotions is being able to
retain your belief in the real fundamentals of the business, and don't
get too concerned about the stock market. More than anything,
investors' own emotions can be their worst enemy.

15. One fine day he realizes, that he is no where near to his LT goal and the
only thing which he has common with Buffett is his recently bought 5 bed
room home .
So what is hindering him from becoming the next Warren Buffet :
 Self control Bias
 Loss Aversion Bias
 Regret Aversion Bias
 Overconfidence Bias
 Endowment Bias

16. So how can we help Mr.Binjing ….
 Its difficult to make him the next Buffett but we can definetly save him from
going bankrupt (if this situations continues…) ,by educating him on his
emotional biases.
 The more we are aware of the emotions we posses towards the
investment/finances ,we can limit the poor investment choices to manifold.
We must ask him to define his long term and short term goals in quantitative
terms rather that qualitatively and it has to reconcile with his risk tolerance .
 In term of investment time horizon he has three stages ,first stage is 4 years
where his both sons will be entering college and his second stage is till his
retirement .Third stage is retirement period.
 He need to decide what is the retirement amount he wants in his retirement
portfolio to have in 15 years time and it depends on the how much he would
save during his working period.

17. Failing to plan is planning to fail……plan before its too late