cfa caymans may 2016
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Crashes, Terrorists, Sharks - Oh, My!
Why investors fear the wrong things,
and what you can do about it…
CFA Society Cayman Islands
May 2016
Barry Ritholtz
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This evening’s discussion:
I. What do we fear – & why?
II. How do our fears impact our
performance – as analysts & investors?
III. Can we manage these issues? (Yes)
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Part I: What do we fear – & why?
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You Are Going to Die . . . Here’s How.
Shark : A perfectly evolved killing machine, immortalized in Spielberg’s 1975 film, “Jaws.”
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Source: Ritholtz.com
Death by Selfie
1 Fell off a cliff in S. Africa.
2. Live hand grenade (2).3. Oncoming train (3).
4. Electrocutedby high-voltage wire (1).
by live wires (1)6. Shot in head with a gun.7. Fell from bridge.
8. Fatally shot himself9. Fell down Taj Mahal steps
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6-10 people per year are
killed by sharks worldwide
Other large predators:
Lions (100)
Elephants (100)Hippos (500)
Crocodiles (1,000)
Dogs (25,000)
Snakes (50,000)
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Source: Gates Foundation, CDC
The Deadliest Animal in the World
Mosquitoes are the deadliest creature on earth;
(Human are only second)
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Source: LA Times
What killed Americans in 1900 vs. 2010
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Risk of Terrorism
Source: CDC, Mueller & Stewart, Terror, Security, and Money.
2010: U.S.
noncombatant
fatalities from
terrorism
worldwide = 25
2011: Terror
deaths = 8
Annual deaths
due to struck
by lightning =
29 .
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Your Actual Risk
You are …
35,079 times more likely to die of heart disease
33,842 times more likely to die of cancer
… than a terror attack.Source: CDC
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Fear of Flying ?
Max Planck Institute (Berlin)
Fear leads to
emotional
decisions
which leadto poor
outcomes
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What are we afraid of in Markets?
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Crash! Hyperinflation! Dollar Collapse!
Market Crashes
HyperInflation
Collapse of the
Dollar
Looking foolish…
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S&P500 Declines of 20% (or more)
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Faber on Hyperinflation: “Not A Matter Of If But When” –Business Insider, 9/23/2010
'The Bear Market Is Starting' Marc Faber –CNBC, August 3, 2011
Faber: “The Dollar's Value In The Future Will Be Zero” –Business Insider, 4/18/ 2011
Marc Faber: “We Could Experience A 1987-Style Crash This Year” –Business Insider,
5/10/2012
Marc Faber: “Look out! A 1987-style crash is coming.” –CNBC, August 8, 2013
“2014 crash will be worse than 1987's” Marc Faber –CNBC, April 10, 2014
“Dr. Doom calls bubble, adding to gloomy calls” –CNBC, Nov 2, 2015
“Asset Markets Will Crash Like Titanic” -Bloomberg, January 6, 2016
Catastrophizing Markets
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Global Central Banks Are Running ‘Out of Ammo’
(CNN/Money February 9, 2016)
Rate-Hikers At the Fed Are Running Out of Ammo
(CNBC May 13, 2015)
Fed Has No Ammo Left (USA Today March 2014)
Federal Reserve: What Happens When The Fed Really
Does Run Out of Ammo? (Time February 27, 2013)
Fed Running Out of Ammo (Politico July 31, 2012)
Fed Out of Ammo For Economy (WaPo 8/26/ 2011)
Fed Running Low on Ammo (WSJ August 26, 2010)
Fed Running Low on Ammo (Reuters August 18, 2009)
Catastrophizing Central Bankers
Economist, Feb 20th 2016
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Part II: How do your fears impact performance?
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1. Herding, Groupthink
2. Optimism Bias
3. Confirmation Bias
4. Expert Opinions
5. Recency Effect
6. Endowment Effect
7. Hindsight Bias
8. Risk Aversion
Behavioral Economics Neuro-Finance
How Your Brain Interferes with Your Investing
Risk Aversion
1. Anticipation vs. Rewards
2. Selective Perception/Retention
3. Words vs Images
4. Pattern Recognition
5. Data vs Narrative
6. Cognitive Dissonance
7. Species of Dopamine Addicts
1. Misunderstanding risk
2. The purpose of fear
3. Black Swans
4. Evolutionary baggage
5. Biggest Financial Fears
6. Overcompensation
7. What hurts performance
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Off Label Use
antihistamine diphenhydramine. sildeenafil
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Your Brain is being used “Off Label”
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Risk Aversion: Pleasure versus Pain
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Source: DALBAR
Investor Performance (10 Years)
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Investor Performance (20 Years)
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Source: Ritholtz.com
Sentiment Cycle
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Source: Ritholtz.com BigCharts.com
These are poorly designed tax cuts - Stay Out of Markets!
2003: Politics and Asset Management Don’t Mix
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Source: Ritholtz.com, BigCharts.com
2003 Tax Cuts > $1 Trillion
Up over 90% over 4 years
2003: Politics and Asset Management Don’t 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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Source: Ritholtz.com, BigCharts.com
FASB 157, ZIRP, QE +VERY Oversold Markets
Up 207% over 75 months
2009: Politics and Asset Management Don’t Mix
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Part III: How can we manage these issues?
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Defining Investment Risk
“The probability that actual
returns on an investment will be
lower than the expected returns.”
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Fear of Deadly Viruses
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Reward !
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35
MSCI World Index,1970–2013
$43
US homepriceshitbottom
Fiscalcliffworries
Euro zonedebtcrisis
S&P 500down 46%
Subprimemortgagecrisis
HurricanesKatrinaand Rita
Iraqwarbegins
Dotcomstockcrash
9/11terroristattack
Y2KScar
e
Russianfinancial
crisis
Asiancurrency
crisis
Income taxratesrate
IraqinvadesKuwait
Savingsand loancrisis
Dow drops23% on BlackMonday
USinflationat13.5%
BusinessWeek:“The Death ofEquities”
Gold hits
record high
S&P 500down43%
Oil pricesquadruple
Arab oilembargo
1970 1980 1990 2000 2010 2013
1
A disciplined investor looks beyond the
concerns of today to the long-term growth
potential of markets.
US homeprices hitbottom
Fiscalcliffworries
Eurozonedebt crisis
S&P 500down 46%
Subprimemortgagecrisis
HurricanesKatrinaand Rita
Iraq warbegins
Dotcomstockcrash
9/11terroristattacks
Y2KScare
Russianfinancial
crisis
Asiancurrency
crisis
Income taxrates rise
IraqinvadesKuwait
Savings and
loan crisis
Dow drops 23% onBlack Monday
US inflationat 13.5%
BusinessWeek:“The Deathof Equities”
Gold hits
record high
S&P 500down 43%
Oil pricesquadruple
Arab oilembargo
1970 1980 1990 2000 2010 2013
In US dollars. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is noguarantee of future results. MSCI data © MSCI 2014, all rights reserved.
Markets Have Rewarded Discipline
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-9%
12%
28%
41%
82% 85%92%
110%
121%
154%
176%
-50%
0%
50%
100%
150%
200% "The Lost Decade" Total Returns January 2000 - December 2009
36
You Don’t Have to Pick Just One
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37
Portfolio Yield: 2.77%
Annual Expense Ratio: 0.29%Asset Class AllocationInternational Stocks 24%
U.S. Large Cap Stocks 18%
U.S. Investment Grade Bonds 14%
Emerging Market Stocks 9%
U.S. Mid Cap Stocks 8%
U.S. Small Cap Stocks 7%
Mortgage Backed Bonds 6%
Inflation Protected Treasury Bonds 5%
Real Estate Investment Trusts 4%
U.S. High-Yield Bonds 4%
Cash 1%
The Diversified Portfolio
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The Endowment Model
Asset Allocation
Opaque: Illiquid Securities,
Leverage & Little Transparency
Transparent: Liquid Holdings,
Daily Pricing & Complete
Transparency
Operationally Challenging with
Higher Fees
Operationally E"cient with
Lower Fees
Risk measurement through
complex quantitative risk
models
Risk management through
intelligent asset allocation &
diversification
Try to avoid volatility
Use volatility to your advantage
and survive periods of severe
disruptions
Complex vs. Simple
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1. Lack of Discipline2. Excess Trading
3. Lack of Diversification
4. Unnecessary Trading Costs/Fees
5. High Turnover = High Taxes6. Over Confidence
7. Deviating from Strategy (“style drift”)
8. Marrying Forecasts / Predictions
9. Relying on Pundits10. Emotional Decision-making
Why Investors Underperform
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What You Can Control
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Understand Risk:
a) Recognize its importance to
achieving returns; b) Embrace appropriate levels;
c) Beware risk aversion.
Avoid the usual mistakes!
The War Between You & Your Brain
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“We have met the
enemy, and he is us.”
-Walt Kelly, Pogo, 1971
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Barry L. Ritholtz
Chairman,
Chief Investment Officer,
Ritholtz Wealth Management
90 Park Avenue, 18th floor
New York, NY 10016
212-455-9122
Info@RitholtzWealth.com
for more information, please contact
My favorite books on these subjects can be found at
http://www.ritholtz.com/behavioral-books
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