Psychological Issues in Investment (2020-12-07).pptx

PSYCHOLOGICAL
ISSUES IN
INVESTMENT
&
HOW SOMEONE
CAN BECOME A
RATIONAL
INVESTOR?
Md Tapan Mahmud
Shiosaki Lab (D-3)
2020-12-07

PSYCHOLOGICAL ISSUES IN
INVESTMENT
Major Topic 1

HOW SOMEONE CAN BECOME A
BETTER INVESTOR?
Major Topic 2

PSYCHOLOGICAL
ISSUES IN
INVESTMENT
(MAJOR TOPIC 1)
Basic Psychology
Behind Rational
Decision making
for Human

DISCUSSION
POINTS
Where Did We Come From & Why It
Matters?
How Your Brain Responds to Money?
Psychological Biases that Affect
Financial Decisions
Is Money = Happiness?

Where Did We Come From & Why It
Matters?

 Where did We Come From?
 Human evolution started 4 to 7 million years
 Today’s “modern” human brain appeared
150,000 to 200,000 years ago
 Most of this time we were “hunter-gatherers”
 Agriculture was developed about 10,000 years
ago
It means that we’ve spent over 99% of our
evolution as hunter-gatherers
Know Thyself: Where Did We Come From & Why It
Matters?

Emotion: Fear and Social Comparison
 For most of our species’ time on earth we needed
our brains to work in certain way that is impractical
in today’s world
 Fear is our basic emotion
 It has evolved to help us anticipate danger and avoid pain
 Fear (of death) is fundamental because life is
fundamental
 If we die, everything else becomes irrelevant
 Social comparison probably served early man well
 By observing those who had more, our ancestors learned
to get more themselves
 Envy could help people survive!
Matters?

What does this mean For Our Emotion?
 Fear of loss is stronger than the anticipation of
gain
 We process information through short-cuts and
filters to shorten analysis time
 We seek patterns / trends
 Our ancestors used to gather whatever would
improve their odds of survival and to avoid
whatever would worsen them
 Evolution has influenced us to follow our
Matters?

Our Brains Now...
 Three Pounds
 Has tripled in size over our history
 100 Billion Neurons
 Would take 32 million years to count the
connections of just the cerebral cortex
Thinking, fast and slow by Daniel Kahneman: Our
thought process…
(https://www.youtube.com/watch?v=uqXVAo7dVR
U)
Matters?

Money, Dopamine & Addiction
 The neural activity of someone who anticipates
will make money is indistinguishable from that of
someone who is on cocaine or morphine
 Dopamine is involved in the brain's reward and
motivation system and in addiction
 High levels of dopamine are believed to increase
feelings of pleasure and relieve pain
 Getting what you expect gives you no dopamine
kick

Money and Fear of Death!
 When you feel like you deserve the money you
become more excited
 The anticipation is often better than the
achievement
 The longer a sequence has repeated, the more
intensely your brain will respond when the pattern
is broken
 Financial losses are processed in the same areas of
the brain that respond to mortal danger
Daniel Kahneman: Why we make bad decision
about money?

Financial Decisions

Over Confidence
 Men are more overconfident than women in areas
like finance
 Overconfidence leads to too much trading and
higher fees as well as taking too much risk
 The closer the odds are to 50/50 the more we
become overconfident
Psychological Biases that Affect Financial Decisions

Pride and Regret (Get-even-itis)
 Tendency for investors to hold onto losing
investments until they can be sold at the price, they
were originally bought at
 Loss Aversion:
- Selling winners too early and losers too late
- Investors are 50% more likely to sell a winner than a
loser
 Solution:
- Ask yourself: Would I buy this stock if I didn’t own it?
 Get-even-itis: http://www.fool.com.au/2016/07/22/are-
you-an-investor-who-suffers-from-get-evenitis/

Considering the Past
 People tend to use a past outcome as a factor in
evaluating a current risky situation
 We tend to judge the probability of an event by
such information that we can recollect easily
past)
 People take a larger risk after large gains and less
risk after loses
 However, sometimes after losing money some
investors will "double down" to get even
Turkish Proverb: If you burn your mouth with hot
next time you’ll blow on your yogurt

Authority
 Be careful regarding what “experts” say…
 Make sure you don’t follow their advice because
you “like” them
 Consider the incentives of the analysts or experts
 Commission from each trade
Financial Decisions

Scarcity
 The mentality of ‘everybody is having it, I got to
get it too’!
 Ex: Water is running out at the time of typhoon
 IPOs are very hard to grab
 Certain stocks that are “running” in the market are
more attractive and hence scarce

Mental Accounting
 Treating money differently based on its sources
 Salary Vs Bonus / Gift
 Viewing investments individually as opposed to
part of the whole
 Large portfolio development could come to

Representativeness and Familiarity
 Employees owning a high percentage of their
company's stock
 Geographical Bias:
• Canadians owning mostly Canadian stocks
• Greeks keep around 90% of their investments at
home
• Once upon a time, Japanese investors had 98%
investments at home
• Residents of Atlanta owning lots of Coke stocks
• Over 50% of the time an investor becomes
interested in a stock because another person
mentions it!

Social Proof
 Herding (Herd Mentality):
 Buying profitable stocks like others during
bubble and when the bubble bursts, they
in panic selling, leading to stock market crash
 Ex: Buying Enron stocks that lead to crash
What is a bubble?
https://www.youtube.com/watch?v=3vDPowCDWc8
What is a stock market crash?
https://www.youtube.com/watch?v=hobjUY6RZ5A

There is little correlation between money
and happiness!
 Two notable exceptions for these two groups:
 People below poverty line
 People who put a very high value on money
 Its not that money can’t buy happiness:
 Its that once you have enough to meet your basic
needs, more money buys much less extra happiness
than you think it will

IS MONEY = HAPPINESS?
• What makes us happier?
• Strong social ties
• Living in a society with low corruption and high social
security
• Having gratitude for what you have
• Being optimistic about the future and present
• Exercising in a regular basis
• Having someone in your life to share your stresses, crisis
and tragedies with
• Getting older with someone, whom you adore
• Wealth (Not nearly as much as we think…!)
Sadly:
 We are very poor estimators of what will make us happy
 Anticipation is often very different to eventual feeling

What makes us unhappy?
 Comparing poorly to peers
 Little social support and contact
 Envy…
 Prof. Dan Gilbert: The Science of Happiness: What
your mother didn’t tell you!
(https://www.youtube.com/watch?v=BwQFSc9mHyA)
 Prof. Dan Gilbert: The Psychology of Happiness
(https://www.youtube.com/watch?v=mFPOLlp04d0)
 Prof. Dan Gilbert: The Surprising Science of Happiness
(https://www.youtube.com/watch?v=4q1dgn_C0AU)

Financial Planning
 Risk Management
 Retirement Planning
 Estate Planning
 Tax Planning
Life Planning
 Goals
 Holidays
 Social Events
 Property
 Education
Planning is the KEY!

 Keep in mind the psychological biases we are pre-disposed to
 Don’t buy stocks or investments; build a portfolio
 Keep a balance to financial and non-financial happiness
 Having a well thought out plan is essential in order to reach your goals and get
the most out of your life
Conclusion

CASE: PSYCHOLOGICAL BIASES OF AN INVESTOR
• Takashi San graduated from X University and after graduation he remained unemployed for a long
period of time. He saw one of his friends, who could not graduate, making a lot of money from the
stock market. Takashi San met his friend one day and discussed regarding the income that his friend
was making. Therefore, he became very enthusiastic regarding investing in the stock market and
requested his father for some fund. His father did not agree initially, yet, after a bit of argument, he
agreed to spare JPY 1000000 for his son, from his retirement saving. Takashi San was very happy
getting the fund and rushed to his friend with it.
• It was a year of economic boom and the index of the share market was sky-rocketing in a great pace.
Most of the shares were overpriced and were still following an upward trend. His friend suggested
that Takashi San should not invest in stocks only, rather he should be making a portfolio with other
risk-free or moderately-risky investment options. Takashi San considered the Stock market
information of the last 6 months and was sure that investing in shares-only will maximize his profit to
the greatest extreme. He also was a bit defensive and wanted to invest in shares with high reputation,
giving stable return all the way. He was a finance graduate and thought that his understanding
regarding the market is no less than his undergraduate friend. Additionally, he wanted to be rich and
surpass his friend as quickly as he can. Consequently, he invested all of his JPY 1000000 in 2 brand-
stock.
• Unfortunately, the capital market crashed within the next 6 months and Takashi San lost almost all of
his investments!

Query:
1. What sort of psychological issues (biases) were hindering Takashi San’s thought
process?
Instructions:
a. Write you answer in a DOC file and upload it to the zoom chat-box.
b. Name the DOC file as per the name of the team-representative.
c. Your total time is 12 minutes.
d. You can always go back to the slides and review the psychological bias section.
CASE: PSYCHOLOGICAL BIASES OF AN INVESTOR

HOW SOMEONE CAN BECOME A
BETTER INVESTOR?
Major Topic – 02

1. Understand your psychological biases and review those
annually:
• Are you overconfident?
• Do you trade too often?
• Are you influenced by rumors / familiarity?
2. Control your investing environment (to avoid excess
trading, rumors, and pride):
• Have a written investment plan (based on quantitative
criterion) and don’t invest outside that plan
• Check your stocks once per week, not once per hour
• Make trades once per month on the same day of each
month
• Don’t follow chat-rooms, line/facebook investment groups
blindly for investment advices: overconfidence is cooked
here
How Someone Can Become a Better Investor?

3. Know why you are investing?
• Know your personal and family goals
• Review your goals often and invest according to your
Investment Plan and goals
• Set a specific dollar amount in a special retirement account
and only trade that account
How Someone Can Become a Better Investor?
4. Others:
• Avoid penny stocks (<$5): most scams are rooted in such
stocks
• Focus on earning the market return
• Its almost impossible to beat the market and become rich
overnight

HOW SOMEONE
CAN BECOME A
BETTER
INVESTOR?
• Warren Buffet’s Top-
ten pieces of
investment Advice:
• https://www.simplysafedividends
.com/warren-buffett-
investment-advice/

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