1. Behavioral Biases
and Investment Implications
Scott A. Bosworth
Vice President
Date of first use: September 10, 2009.

2. Behavioral Biases
and Investment Implications
“I can calculate the motion of heavenly bodies,
but not the madness of people.”
—Sir Isaac Newton, response to the 1720 collapse of the
“South Sea Bubble”
1

3. Behavioral Biases
and Investment Implications
► What are the common biases?
► How do biases affect decision making?
► How investors can control for biases.
2

4. Behavioral Biases
“. . . emotion overwhelms reason.”
“Financial losses are processed in the
same areas of the brain that respond
to mortal danger.”
Jason Zweig, Your Money and Your Brain (New York: Simon & Schuster, 2007). 3

5. Behavioral Biases
Overconfidence
Hindsight Bias
Familiarity Bias
Regret Avoidance
Self Attribution Bias
Extrapolation
4

6. Overconfidence
► Survey of investors, asked how the market would do and how their
own portfolio would do over the ensuing 12 months.
Market Portfolio
June 1998 13.4% 15.2%
February 2000 15.2% 16.7%
September 2001 6.3% 7.9%
Kenneth L. Fisher and Meir Statman, “Bubble Expectations,” Journal of Wealth Management 5, no. 2 (Fall 2002): 17-22. 5

7. Hindsight Bias
“How could I have been so stupid?”
►Past events seem easy to predict.
►The future, therefore, seems easy to predict.
►Hindsight is not 20/20.
6

8. Familiarity Bias (invest in what you know)
► Provides a false sense of security by giving the impression of control.
► Examples:
– Concentrating wealth in a few well-known companies with which you
are familiar.
– Holding a “legacy” stock.
The market does not reward investors with risk premiums
for “loyalty” or “familiarity.”
7

9. Regret Avoidance
“I won’t make that mistake again.”
► Counterfactual thoughts lead to regret.
► “If only I had not made the decision to buy X.”
 You did buy X, so not buying it in the past
is counterfactual.
Diversification neither assures a profit nor guarantees against loss in a declining market. 8

10. Self Attribution Bias
“Look how smart I am.”
OR
“No one could have seen that coming.”
Credit: Attribute success to self-possessed skills or inherent abilities.
Blame: Attribute failures to externalities that we could not know or control.
9

11. Extrapolation
Historical returns
are based on old
news.
Future returns are unknown . . .
10

12. “News”
► A report of recent events.
► Previously unknown information.
► Something having a specified influence or effect.
Source: Merriam-Webster online dictionary. 11

13. Magazine publication dates: Fortune, March 3, 1997 (America’s Most Admired Companies); Money, August 1997 (Don’t
Just Sit There… Sell Stocks Now); Money, May 1999 (Tech Stocks, Everyone’s Getting Rich!); Time, September 9,
1974 (Economy: The Big Headache); Time, October 15, 1990 (High Anxiety); Time, November 2, 1987 (The Crash).
12

14. Steve Forbes
Publisher, Forbes Magazine
“You make more money selling advice than
following it. It’s one of the things we count on
in the magazine business—along with the
short memory of our readers.”
Excerpt from presentation at The Anderson School, University of California, Los Angeles, April 15, 2003. 13

15. Investor Behavior
In 2008 the S&P 500 Index returned -37.72%
In 2008 the average equity investor earned -41.63%
From Jan 1989 through Dec 2008 (20 Years):
► Average equity investor earned annual return of 1.87%
► Underperformed the S&P 500 Index by 6.48%
► Underperformed inflation by 1.02%
Takeaways:
► Investors buy high and sell low.
► Returns are more dependent on investor behavior than fund performance.
► Buy-and-hold investors typically earn higher returns over time than those who
time the market.
The S&P data are provided by Standard & Poor’s Index Services Group.
Dalbar, Inc., “Quantitative Analysis of Investor Behavior 2009,” (www.dalbar.com). DALBAR develops standards for, and provides research,
ratings, and rankings of intangible factors to the mutual fund, broker/dealer, discount brokerage, life insurance, and banking industries. They 14
include investor behavior, customer satisfaction, service quality, communications, Internet services, and financial-professional ratings.

16. The Appeal of Market Timing
► What if you only invested in the stock market in months when it
outperformed T-Bills?
► From 1990 through 2008, a $1 MM investment in the following would
have returned:
US T-Bills (buy and hold) $2.12 MM
US stock market (buy and hold) $3.94 MM
US stock market only when equity
premium is positive $136.21 MM
► Wealth from timing would be 34 times that of a buy-and-hold strategy.
US stock market measured by CRSP 1-10 Index. Third calculation based on highest asset class return each year from previous slide.
CRSP is a research center at the Graduate School of Business (founded in 1898) of the University of Chicago. CRSP is a non-profit
center which also functions as a vendor of historical data. CRSP end-of-day historical data covers roughly 26, 500 stocks – active and
inactive – listed on the NYSE, Alternext (formerly known as the Alternext (formerly AMEX)), NASDAQ and ARCA exchanges. OTC
bulletin board stocks are not included.. US T-Bill data provided by Ibbotson Associates. .
Treasury securities are negotiable debt issued by the United States Department of the Treasury. They are backed by the government’s
full faith and credit and are exempt from state and local taxes. Stock is the capital raised by a corporation through the issue of shares 15
entitling holders to an ownership interest of the corporation.

17. Perspective on Markets
“October is one of the peculiarly dangerous
months to speculate in stocks. The others are
July, January, September, April, November, May,
March, June, December, August, and February.”
—Mark Twain
“The market can stay irrational longer than you
can stay solvent.”
— Quotation attributed to John Maynard Keynes
Dan Wheeler is the founder of the Dimensional Fund Advisors Financial Advisors Services. 16

18. Perspective from Academia
“As I have often argued: Even the Almighty cannot
determine a single correct value for the market as a whole.”
—Burton Malkiel, “How Much Higher Can the Market Go?” Wall Street
Journal, September 22, 1999.
“There’s something in people, you might even call it a little
bit of gambling instinct . . . I tell people [investing] should be
dull. It shouldn’t be exciting. Investing should be more like
watching paint dry or watching grass grow. If you want
excitement, take $800 and go to Las Vegas.”
—Paul Samuelson, 1970 Nobel Laureate in Economics, in “The Ultimate
Guide to Indexing,” Bloomberg, September 1999.
17

19. Risk and Return
► Free markets must compensate investors for bearing risk.
► The market is “forward looking.” Expectations of risk are priced into
the market currently.
► Risk is higher (and prices lower) during recessions.
► Expected returns for risky assets should be higher during recessions.
Expected return is the percentage increase in value a person may anticipate from an investment based on the level of risk associated with
the investment, calculated as the mean value of the probability distribution of possible returns.
Dalbar, Inc., “Quantitative Analysis of Investor Behavior 2009,” (www.dalbar.com). DALBAR develops standards for, and provides research,
ratings, and rankings of intangible factors to the mutual fund, broker/dealer, discount brokerage, life insurance, and banking industries. They
include investor behavior, customer satisfaction, service quality, communications, Internet services, and financial-professional ratings. 18

20. Disciplined Approach
What You Can’t Control What You Can Control
– Pick winning stocks – Reduce expenses
– Pick superior managers – Diversify portfolio
– Time the markets – Minimize taxes
– Financial press – Discipline
Diversification neither assures a profit nor guarantees against loss in a declining market. 19

21. Nick Murray
“At the end of our investing lifetime, it won’t
matter what your funds did, it’ll matter what you
did. And what you did will be a pure function of
the quality of the advice you got—from one
caring, competent [advisor], and not from any
number of magazines.”
Diversification neither assures a profit nor guarantees against loss in a declining market.
“Murray on Marketing,” Investment Advisor Magazine, October 1994. 20

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