Behavioral Biasesand Investment Implications

Dimensional Fund Advisors is an investment advisor registered with the Securities and Exchange Commission. Consider the investment objectives, risks, and charges and expenses of the Dimensional funds carefully before investing. For this and other information about the Dimensional funds, please read the prospectus carefully before investing. Prospectuses are available by calling Dimensional Fund Advisors collect at (512) 306-7400; on the Internet at www.dimensional.com; or, by mail, DFA Securities LLC, c/o Dimensional Fund Advisors, 1299 Ocean Avenue, Santa Monica, CA 90401. Dimensional funds are distributed by DFA Securities LLC.Date of first use: September 10, 2009.

Scott A. BosworthVice President

Behavioral Biasesand 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

Behavioral Biasesand Investment Implications

►What are the common biases?

►How do biases affect decision making?

►How investors can control for biases.

2

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

Behavioral Biases

Overconfidence

Hindsight Bias

Familiarity Bias

Regret Avoidance

Self Attribution Bias

Extrapolation

4

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.

Overconfidence

►Survey of investors, asked how the market would do and how their own portfolio would do over the ensuing 12 months.

5

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

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

“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.

Regret Avoidance

8

“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.

Self Attribution Bias

9

Extrapolation

Historical returns are based on old news.

Future returns are unknown . . .

10

►A report of recent events.

►Previously unknown information.

►Something having a specified influence or effect.

“News”

Source: Merriam-Webster online dictionary. 11

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

Steve ForbesPublisher, 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

Investor BehaviorIn 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.Dalbar, Inc., “Quantitative Analysis of Investor Behavior 2009,” (www.dalbar.com). 14

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:

► Wealth from timing would be 34 times that of a buy-and-hold strategy.

US T-Bills (buy and hold) $2.12 MMUS stock market (buy and hold) $3.94 MMUS stock market only when equity premium is positive $136.21 MM

US stock market measured by CRSP 1-10 Index. Third calculation based on highest asset class return each year from previous slide. CRSP data provided by Center for Research in Security Prices. US T-Bill data provided by Ibbotson Associates. .

15

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

16

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

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.

18

Disciplined Approach

What You Can’t Control– Pick winning stocks

– Pick superior managers

– Time the markets

– Financial press

What You Can Control– Reduce expenses

– Diversify portfolio

– Minimize taxes

– Discipline

19

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.”

“Murray on Marketing,” Investment Advisor Magazine, October 1994. 20

www.dimensional.com