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Nl bfm january 2012


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Nl bfm january 2012

  1. 1.                               2010-2011 BFM Newsletters  Summary             Founder’s word     Happy New Year!   To begin 2012 with all the tools you may need, BFM created   for you this compilation of all the newsletters of 2010 and   2011.   You will discover or rediscover the valuable information BFM   gathered under three major themes: A, B, C.       To know more about a specific subject you can also refer to the next summary:     Understanding Behavioral Finance-Rationality & Decision Making……..…………….………2   Humans can’t analyze all the information received……………………………………....….....2   Challenges in Financial Advising From the Scope of Behavioral Finance…………………..…4   Investment Decision Making………………………………………………………..............…4   Countries and Culture in Behavioral Finance………………………...…………………..……4   Human Brain and Decision-Making………………………………………………………..…5   Train Your Brain to Win Big………………………………………………………………….6   Be Aware of your Emotions - Step Away from Yourself - The Flaws of our Financial Memory……….6   So Thats Why Investors Cant Think for Themselves……………………………………...…7   How to Pick Better Mutual Funds?……………………………………………………...……8   Performance May Lower your Returns…………………………………………………...….11   Lets Put Things in Perspective……………………………………………………………....12 Appendix……………………………...……………………………...…………………...…15 January  2012   © 2012 Bourbon Financial Management, LLC ~ All Rights Reserved ~ ~ (+1) 312 909 6539                                                     1  
  2. 2.   Understanding Behavioral Humans can’t analyze all the Finance-Rationality & information received Decision Making          Behavioral Economics explains how the Please find below a one-minute video.process of decision making functions amongcommon people. It elaborates on the role ofemotions and vision. Video: Selective Attention Test  We use vision more in the day than we doanything else, so we are good at it. But thetruth is that our vision tricks us. If we havethese repeatable mistakes in vision which we This video shows that human attention isare good at, what are the chances we don’t limited and that we can’t analyze all themake more mistakes in that we are not good information we, ex. financial decision making?Do you want to know how powerfullyillusive our vision is and how it dominates We tend to pick the information that weour decisions? need to prove that our thinking is correct. If   we are bullish and long the financial market,   we tend to read bullish reports. Individuals See the entire Newsletter at:   Newsletter, January 2011 have a tendency to simplify decisions (good   company -> good investment, momentum   strategies -> chasing performance).   Furthermore, investors believe their   information is correct and they are better at   If you want to learn more about interpreting information and making   behavioral finance and the role of decisions. We have an inability to fully   Psychology, here is a long and incorporate new information into risk and popular video (viewed 28,000 return forecasts. The failure to recognize the   times!) of a class of Robert Shiller, true risk of an investment makes us trade   Professor of Economics at Yale more frequently than can be justified by the   University. information. Also, we tend to remember   only the good decisions so our memories   Behavioral Finance : The Role of don’t disagree with our opinion on our   Psychology   abilities.                   Refer to “We are all Predictability   Irrational - Dan Ariely” on YouTube     link:         We are All Predictably Irrational                               2  
  3. 3.                                                                 See More tricks at: The Human Brain…tricks us whenever it can!                   3  
  4. 4.     Challenges in Financial   Investment Decision Advising From the Scope   of Behavioral Finance   Making               In today’s world, especially after the recent Since many of you like Behavioral Finance financial meltdown, understanding the research to help you improve your decision human emotions and sentiments before making process, investing money is capturing interests of researchers and advisers. We too continue our long love with Behavioral Finance and present you some interesting findings by Please find the Newsletter researchers in this area. « Investment Decision Making » at: Newsletter, May 2011   Please see the Newsletter to learn   more about: Newsletter, July 2011 You will find some information about:   • Intuitive and Reflective Minds • Asset Allocation • Investor Paralysis • Information Overload • Lack of Investor Discipline • The Effect of Myopia and Loss Aversion on Risk Taking • Regaining and Maintaining Trust • Making Intelligent Decisions • Overcoming Loss Aversion • The practices that an investor • Overcoming Procrastination should try to follow • The Ulysses Strategy • Some things that an investor   should try not to engage in       Countries and Culture in Behavioral Finance                 Have you analyzed why Chinese exhibit higher risk tolerance than Americans? Have you ever   wondered how Muslims invest money? And did you know a country’s corruption level has an   impact on its own diplomats?     Asians, Americans, Europeans, Africans, Australians… The world is a mix of people from these   continents with different ideologies and cultures. But what is fascinating is that there is   something which is common between these diverse cultures. Guess what? It is MONEY!         Find all the answers at: Newsletter, June 2011                       4  
  5. 5.   We can summarize some of the practices that should be followed: · Financial advisers need to probe their clients more about their culture. Also important is to know the client’s obligations towards others. Individualistic and collectivistic groups have different styles of thinking. This reflected in their investment decisions. · Continuously strive to learn more about investing. · Understand the complexities in investing. The adviser will have to do more research and be sure that he does not fail his fiduciary duty. · Saving rates depend a lot on culture. It is important to understand your culture before you make investment decisions. Higher saving rates cultures are more risk tolerant that low saving rate cultures. · Many investors exhibit different abilities and willingness towards risk. Always honor the willingness to risk because the investor feels comfortable if his risk level is under his/her control.       Human Brain and Decision-Making            We can point to some general practices that can • Avoiding making any important investmenthelp investors improve their investment decision decision while being in a passive state ofmaking: mind.• Thinking more analytically when making important financial decisions. • Creating a balance between being patient and being dynamic about investment choices.• Being pro-active, curious and non- assumptive at all times and spending time to   evaluate investments, possible risks and   benefits.  Let’s see the Newsletter « Human  Brain and Decision-Making » for• Continuously striving towards improving  more information, August 2011   self-control and avoiding hastiness.                   5  
  6. 6.   Be Aware of your Emotions Train Your Brain to Win Big   - Step Away from Yourself - The Flaws of our Financial Memory   When Playing the investing game, it’s easy to let your impulse make all the wrong See  the  entire  Newsletter  at:   moves. Learning to trick yourself can help. Newsletter,  November  2011   Why do smart people do such stupid things with their money? The answer often lies in neuroeconomics, a hybrid of neuroscience, · Be aware of your own emotions economics, and psychology that drills down and cognitive traps to make smarter to the biological bedrock of decision- decisions. making. · Step away from yourselves to be Even when we think we are being rational, more rational. we are often driven by impetuous emotions of which we are barely conscious. Therefore, · Remember that we unconsciously the keys to investing success, whether it’s for make decisions based on positive retirement or just for fun, are strategies and memories. tricks to prevent the heat of the moment from melting your better judgment. · Learn about financial history to reduce the number of mistakes. Do not extrapolate recent past. Ten Tricks for Better Investing: · Keep a well-diversified portfolio T ake the Global View and an investment diary. H ope for the Best-But Expect the Worst I nvestigate Then Invest · Have a Financial Plan. N ever Say Always K now What you Don’t Know “when we’re feeling good. T he Past Is Not a Prologue Complex decisions, involving W eigh What They Say I f it Sounds Too Good to Be True, It multiple options… demand our Probably Is best thinking. Yet those very C osts are Killers E ggs Go Splat decisions seem to induce in us emotional reactions that impair our ability to do just the kind ofThe article: Train your Brain to Win thinking that is necessary.” Barry Schwartz                     6  
  7. 7.   So Thats Why Investors In the experiment, researchers from Cant Think for Themselves University College London and Aarhus   University in Denmark asked 28 people to submit a list of songs they wanted to buy online and then to decide which they would most like to own. Then the From February through May, the Dow participants viewed the ratings of the Jones Industrial Average gained more same songs by two professional music than 1000 points in an almost experts. Meanwhile, a magnetic resonance uninterrupted daily march upward. Then imaging machine recorded the patterns of came the "flash crash" of May 6 and day activity in their brains. Finally, as a way to after day of losses through May. Now, in measure the influence of the experts mid-June, the market has been up six of views, the participants had the chance to the past seven days. change their minds about which songs they wanted the most. What accounts for these sudden moves? Why do investors so often seem to The brain scans showed that as soon as resemble a school of fish, all changing people learned they had chosen the same direction together? song as the experts, cells in the ventral Sometimes the most interesting answers striatum—a reward center wired with to financial questions come from dopamine neurons that scientific labs. A study respond to pleasures like published in the journal Current Biology found that "When someone sugar and sex—fired intensely. the value you place on influences you, it something is likely to go up happens very quickly, when other people tell you it "If someone agrees with is worth more than you in under a second," your choice, its thought, and down when intrinsically rewarding in others say it is worth less. Daniel Campbell- the same way food or money is rewarding," More strikingly, if your Meiklejohn   says one of the evaluation agrees with what others tell you, then a part of experimenters, Chris your brain that specializes in Frith of University processing rewards kicks College London. into high gear. Why might other peoples estimates of In other words, investors often go along what something is worth lead you to with the crowd because—at the most change your own? Their appraisal could basic biological level—conformity feels make you unsure that yours is correct. good. Moving in herds doesnt just give You might become more popular once investors a sense of "safety in numbers." you agree with others, or joining the It also gives them pleasure. experts may make you feel like one yourself. "We are very social creatures," That may help explain why market says Prof. Frith, "and we are desperately sentiment can change so swiftly, why true keen to be part of the group." contrarians are so hard to find and why investors care so much about the "When someone influences you, it "consensus view" on Wall Street. happens very quickly, in under a second,"                   7  
  8. 8.   says the lead researcher, Daniel Campbell- Meiklejohn of Aarhus University. "That How to Pick Better Mutual mechanism can travel quite quickly through a population." Funds?   The experiment also showed that learning that the experts agree with one another— regardless of whether you agree with them—triggers activity in the insula, a brain region associated with pain and See the entire Newsletter at: heightened body awareness. This suggests Newsletter, October 2011 that the agreement of others may have a special ability to grab our mental attention. No wonder a consensus opinion is almost impossible for many PEOPLE + PROCESS + investors to ignore. PHILOSOPHY = PERFORMANCE Benjamin Graham, the founder of value investing, wrote that "the market is not a weighing machine, on which the value of At BFM, we are very analytical and we each issue is recorded by an exact and believe that asset allocation is more impersonal mechanism, in accordance important than stocks or mutual fund with its specific qualities." Rather, he selection…but many of you have asked us to added, "the market is a voting machine, share our disciplined due diligence whereon countless individuals register process to selecting investment managers choices which are the product partly of and mutual funds. reason and partly of emotion." Herding, Graham understood, is part of the human You should not be over confident in condition. pursuing activities beyond your expertise. For example, practicing skydivingThus, if you buy individual stocks, you without a professional skydiver or dancingshould note which way the herd is Ballet without a ballerina’s guidance canmoving—and go the other way. You harm your body. Investing your wealth, justshould get interested in a stock when its like skydiving and ballet dancing, is scienceprice gets trampled flat by investors but also an art. Investing withoutstampeding out of it. The list of new 52- knowledge is like jumping into a valleyweek lows is a rough guide to what the without a machine has been trashing lately.Then run your own weighing machine,studying the companys financial Selecting a good mutual fund is extremelystatements, products and competitors to difficult. Only 20% of funds maydetermine the value of its business—while outperform their benchmark over the longignoring the current price of its stock. And run. 40% of funds that were in business 10make a permanent record that thoroughly years ago are now gone. A fund can be atdetails your rationale for making the the top one period and be at the bottom theinvestment. That way, you set in stone next one.exactly where you stood before the herdbegan trying to sweep you away. (Source: As you can see, mutual fund returns can beWSJ-06/21/10 very different. Thus, effective organized financial planning is important.                   8  
  9. 9.                            The debate between active and passive Short-term greed and impatience will leadmanagement (investing in index, passive investors to fail. Before investing you shouldfunds and ETFs) is a constant discussion develop confidence in the fund and theamong individuals in the financial world. patience required for long-term success.There are qualitative and quantitative factors Otherwise, you should invest in index andthat need to be understood and analyzed passive funds (low costs).correctly before picking a good fund.You should decide to be Human emotions are theeither patient with active “Do not wish for quick biggest obstacle to investormanagers or seek a results, nor look for success. Proper research goespassively managed small advantages. If you well beyond the numbers. It alsoapproach. The vast majority requires regular meetings or calls seek quick results, you with the managers. Naturalof long-term top will not attain theperforming managers will human behavioral tendenciesendure periods of lousy ultimate goal.” during the manager selectionperformance. and termination process Confucius. generally leads to failure so we· 85 percent of all ten- recommend a rigorous process.year top quartile funds spent   We believe that qualitativeat least one three-year stretch metrics for selecting mutualin the bottom half of their peer group (they funds are as important as quantitativespent about 23 percent of all their three-year metrics.periods in the bottom half of their peergroups).· 62 percent of ten-year top quartilefunds spent at least one five-year stretch inthe bottom half (19 percent of rolling five-year periods in the bottom half of their peer  groups). Source DiMeo.                             9  
  10. 10.  What traits and factors do we look for, Quantitative factors:review carefully, and monitor constantly? 1. Fees/ Expense ratio: Funds in theQualitative factors: cheapest quintile were more than twice as likely to beat the average for their categories1. People: education, qualifications, than the most expensive quintileexperience, depth, stability, diversity, qualityand diligence of the investment team 2. Tenure / Experience / Track Record of(portfolio managers, analysts, traders, the Portfolio Managers and Analysts. Theauditors…) average tenure maybe close to 6 years only…2. Investment philosophy that isconsistent, clearly articulated and 3. Fund ownership** by the portfoliounderstandable management team3. Investment process and style based on 4. 5 and 10-year Information Ratio (IR)meritocracy that are transparent, repeatable, and peer ranking. The IR measures the risk-consistent, and definable with good buy and adjusted return for assessing thesell discipline and risk management performance of active portfolio managersprocedures 5. Long-term after tax4. Stewardship: a corporate culture of return/performance: GMO Emergingexcellence, with clean regulatory history, Country Debt had a 10-year annual returnboard integrity, independence, ownership was 14.54% ($10,000 became $38,880) butand compensation who will put your after tax, the post-tax return was 9.80%interests first ($10,000 became $25,468 or 35% less)5. Firm ownership structure 6. Consistency of portfolio returns with the investment process (attribution reports)6. Manager compensation and incentivesstructure (salary, bonus, stocks, shares…) 7. Funds concentrationthat reward individual contributions 8. Tracking Error and Active Share: these7. High conviction approach that is distinct numbers represent how much the fundand with potential to outperform. returns deviate from the benchmark8. What percentage of research is generated 9. Beta and Correlation with the fund’sinternally (vs. sell-side research from Wall true Benchmark (R square)Street)? 10. Inflows/Outflows and total assets in theSuch data may not available by directly fund today and 5 years agolooking into sources like Bloomberg andMorningstar. This requires contacting every 11. Up/Down capture ratio and maximumfund and requesting them to provide the drawdowndata.We also review the portfolio composition, 12. Sortino Ratio which measures the risk-size (small or large cap) and style of the adjusted returnfunds, manager concentration, and if amanager has closed a fund to new investors 13. Volatilityin the past and ask how they decide to close 14. Turnover which measures the numberit in the future. of times securities/shares are replaced/traded                   10  
  11. 11.   Performance May Lower your Returns   1. Dalbar Research Institute shows that investor’s performance does not equal investment performance. They found the following annualized returns for investors from 1987 to 2006 (similar results are found for different time period): -The average equity-fund investor realized an annualized return of 4.30% ($100,000 became $222,536). -The market timer equity fund investor realized an annualized return of -1.80% ($100,000 became $70,814). -The market (S&P 500) realized an annualized return of 11.80% ($100,000 became $832,519).   2. Using another research report from Lipper and DALBAR, we can see, in the chart below, that chasing performance may lower your returns. This research shows how mutual fund investors’ behavior affects the returns they actually earn.  Source:Lipper andDALBAR                     11  
  12. 12.   your stone age brain may be good with physical risk, but it is the same one that Lets Put Things in governs your investment gut - it is not a Perspective good investment manager. As you know, we take a long-term, academic and disciplined approach to investing andWe decided this time to send you some we try not to react emotionally to marketcharts to help you put things in perspective swings, unlike many individual investorssince the U.S. stock market went down 8% who tend to sell equities and lock in lossesin July and August. Note that the market is during down-turns. The portfolios westill up 5% in the last 12 months and up recommend are always customized and well-70% since March 2009. diversified. Markets volatility and declines give opportunity to rebalance the portfolios.The charts attached may help you draw yourown conclusions without being manipulatedby the media, friends… See the entire Newsletter at:In Summary: Newsletter, September 2011· This summer’s stock decline wasnothing exceptional· The economy doesn’t look that bad· Stocks are not expensive Details· Stocks perform well over the long-term, sometimes right after a majorcorrection and/or spike in volatility •U.S. Stocks have been going up in the long run and outperformed bonds most of the time over any 5-year periodsWe still think that the chance of anotherrecession may be 20% - 50% before 2014 •Historically stock market declines havebut the charts should help you to put in been much worse: down 86% in 1929-32,perspective what happened this summer. 49% in 2001, 57% in 2007-09…A huge part of successful investing isjust avoiding common errors like •Other asset classes have seen much worsepanicking. The goal is not to be error-free; decline:it is to be right more than wrong over time. -Long U.S. Treasury Bond real return wasHumans are intuitive creatures, but markets negative 67% between 1941 and 1981.are inherently counterintuitive. Investing, -Gold was down 62% between 1980 andlike medicine and many fields of science, 1986is a probabilities game, not a certainties -Japan Stocks were down 82% between 1990game. Investing requires faith that and 2009Capitalism is not perfect in the near term -Most declines have been followed by 5but eventually gets very close longer term. years of gainsSometimes, doing nothing is the best •Nearly every significant up year for thestrategy... and it is not easy... When you are markets had also a significant intra-yeartempted to go with your gut, remember that decline                   12  
  13. 13.   •When the volatility is high, markets often •When consumer sentiment bottoms, the rise following 12 months tend to be good for •U.S. Companies are in much better shape stocks. Extreme pessimism in consumer (profits, cash holdings, dividend payouts) confidence may be a bullish sign for the than in 2000 market •The Yield curve is usually flat before •Moderate GDP Growth (2%-3%) has not recessions. It is far from flat now been bad for stocks historically. But can we keep a 2%+ growth? •DIVERSIFICATION WORKS!U.S. Stock Market History, 1871 – April 2011 Initial Job Claims Is Down: Usually, it is Up Before Recession – (Recessions are in grey)                     13  
  14. 14.   Stocks Outperformed Bonds Most of 5-Year Periods   Historical Markets Declines: We Have Seen Much   Historical Markets Declines: We Have Seen Much   Please find the first BFM Video: Video You will find investment strategies to help you reach financial security, grow your assets and achieve a comfortable retirement.                     14  
  15. 15.       Apendix     4. Think about Estate Planning: LookYear-End Financial into how various trusts, such as a bypassPlanning Tips trust or grantor retained annuity trust, might help you reduce your estate tax liability. 2010 YEAR-END FINANCIAL PLANNING : What you should have done ! 5. Accelerate or Defer deductions: HaveWith the end of the year approaching, here your tax advisor determine now if you haveare some important tax and financial any Alternative Minimum Tax (AMT)planning measure you can take to reduce liability for 2010. If so, you may consideryour taxes and improve your financial deferring taxable income to 2011 orposition. accelerating or deferring deductions in 2010 to minimize AMT.1. Sell some stocks, bonds, or mutualfunds before the increase in capital and 6. Spend all your money in your FSA: Useincome tax rates: Look at carryovers of any balance in your employer’s Flexiblepast tax losses and whether any potential Spending Account (FSA) for qualifiedlosses on depreciated securities would be medical expenses by year-end 2010. Whenmore valuable in 2010 or in future years. If estimating your contributions for next year,you end up with a loss, either short or long consider the increasing costs of uncoveredterm, $3,000 of that loss can be used to medical expenses and changes in youroffset ordinary income. A $3,000 loss will company’s medical insurance you approximately $840 in taxes,assuming you are in the 28% bracket. Short- 7. Take your Required Minimumterm capital gains (one year holding or less) Distribution (RMD) once you turn 70.5are taxed at ordinary income tax rates up to years old (or you can be subject to a 50% tax35% in 2010. Long-term capital gains (more penalty!)than one year holding) are taxed at 15%, fortaxpayers in the 25% tax brackets or above.Tax rates should increase in 2011. 8. Fund your 529 higher education savings2. Contribute to your IRA and other plan ($13,000 per person, per beneficiary).company retirement accounts: IRA - 401(k) - 403 (b) accounts provide tax-deferred 9. Other Deductions: In 2010, did you buygrowth. Since January 2010, high-income a new car or first house, upgrade yourinvestors also have the opportunity to existing home to be more energy efficient,convert assets from a Traditional IRA or or pay for a dependent’s higher educationemployer-sponsored retirement plan to a expenses? You may meet the requirementsRoth IRA. A Roth IRA offers tax-free for claiming a tax credit or deduction. Youincome in retirement. could also pay your property taxes by year end if you are a home owner.3. Make Donations: In 2010 you can giftup to $13,000 ($26,000 for a married couple)  free of gift tax.                       15  
  16. 16.    About Bourbon Financial Management, LLCBourbon Financial Management was formed to provide our clients (starting withourselves) with an effective and comprehensive solution for managing their global wealth. Our disciplined and rigorous approach comes from our collective knowledge in servinglarge institutional clients over many years.Our core investment belief is that asset allocation (equities, fixed income, cash, real estate…) isthe single most important determinant of success in any investment plan. The dominant amountof risk and return comes not from your choice of individual investments but from your assetclass mix. Bourbon Financial Management focuses our resources on risk management and assetallocation. Patrick Bourbon, CFAPLEASE SHARE OUR NEWSLETTER: Our newsletter readership is not limited to ourclients. Please tell those you feel may be interested that they can subscribe to their own free copyof the newsletter at Thank you. BOURBON FINANCIAL MANAGEMENT Excellence ~ Experience ~ Ethics616 W. Fulton St., Suite 411, Chicago, IL 60661+1 312-909-6539 ~ www.bourbonfm.comMember of the Financial Planning Association and Academic Affiliate of the NationalAssociation of Personal Financial Advisors. © 2012 Bourbon Financial Management, LLC ~ All Rights Reserved ~ ~ (+1) 312 909 6539                                                     16