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Thisis
your
brain
Your brain weighs 3 pounds, and is 100,000 years old. It is a dynamic, opportunistic, self-organizing system
of systems. MRIs have revealed to Neurologists what our brains looks like when making decisions . We can
observe it 1) in real time; 2) under actual conditions, and 3) in reaction to financial risk/reward stimuli.
Once we begin trading stocks, however, our brains begin to undergo subtle physical change that we can
actually see in the MRIs of Traders . . .
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Thisis
your
brainon
stocks
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A brief intro to
BehavioralEconomics
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Source: Kal, Economist
Herding
Mutual of Omaha
Lone Gazelle
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Optimism Bias: The unfortunate tendency to expect the best possible outcome regardless of the
evidence before you.
Here, Tweetie, Tweetie,Tweetie
Optimism Bias
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The Math of Active Management is Daunting:
1.Only 20% of active managers (1 in 5) can outperform theirbenchmarks in any given year;
2.Within that quintile, less than half (1 in 10) outperform in 2 out ofthe next 3 years;
3.Only 3% stayed in the top 20% over 5 years (1 in 33)4.Once we include costs and fees, less than 1% (1 in 100) manage tooutperform (net).
5.What are the odds you can pick that 1 in 100 manager?
Optimism Bias + DK = Active Management
Source: Morningstar, Vanguard
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1. We tend to read that which we agree
with; We avoid that which disagrees
with our preconceived biases, notions or
ideologies;
2. Our biases change the way we
perceive objects literally, the way we
see the world.
3. The same biases affect our memories
we retain less of what we disagreewith . . .
4.Expectations Affect Perception
Selective Perception & Retention
Confirmation Bias
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Source: Ritholtz.com, WSJ
WSJ: 2007 WSJ: 2010
Beware the Recency Effect
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Source: Ritholtz.com, Fortune, Time
Time, June 2005 Fortune, June 2005
What Just Happened vs. What is Going to Happen
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Source: Ritholtz.com BigCharts.com
These are poorly designed tax cuts - Stay Out of Markets!
2003: Politics and Asset Management Dont Mix
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Source: Ritholtz.com, BigCharts.com
2003 Tax Cuts > $1 Trillion
How did that political trade up over 90% over 4 years
work out for you . . . ?
2003: Politics and Asset Management Dont Mix
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Source: Ritholtz.com, BigCharts.com
Obama is a Socialist! Stay Out of Markets!
2009: Political Investing
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If u cn rd ths . . .
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This animation . . .
. . . is not an animation
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When it absolutely positively
has to deceive your eyes overnight
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Source: Ritholtz.com, Crestmont Research
100 Years of Secular Markets, P/E Expansion & Contraction
Understanding the Long Cycle
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The Narrative Fallacy
Image by German photographer Thomas Hoepker, published in 2006 David Friends book, Watching the World Change
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Source: Ritholtz.com, Morgan Stanley Europe
Composite 19 Secular Bear Markets
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Source: Ritholtz.com
Sentiment Cycle
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We have met the
enemy, and he is us.
-Walt Kelly, Pogo, 1971
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Now I understand thesecognitive issues, what can I
do about them?
Avoid making all the usual errors
investors make!
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1. High Fees Are A Drag on Returns
2. Dont Reach for Yield
3. Never Confuse Past Performance
with Future Potential
4. Asset Allocation Matters Morethan Stock Picking
5. Passive vs. Active Management
6. The Future is Inherently Uncertain
7. Understand the Long Cycle
8. Be aware of your Cognitive Errors9. Allow Compounding to work for you
10. You (and your Behavior) Are
Your Own Worst Enemy
Top 10 Investor Errors
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Barry L. Ritholtz
Chief Investment Officer
Ritholtz Wealth Management
90 Park Avenue, 18th
floorNew York, NY 10016
516-455-9122
for more information, please contact
My favorite books on these subjects can be found at
http://www.ritholtz.com/blog/behavioral-books