Promoting the wealth and well being of your clients managing risk regret fear and hope
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Promoting the wealth and well-being of your clients: Managing risk, regret, fear and hope. Meir Statman Glenn Klimek Professor of Finance Santa Clara University http://lsb.scu.edu/finance/faculty/Statman/Default.htm. January 1997. The Story of Sharon and Russ Gornie Hopes and Fears.

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Promoting the wealth and well being of your clients managing risk regret fear and hope

Promoting the wealth and well-being of your clients: Managing risk, regret, fear and hope

Meir StatmanGlenn Klimek Professor of Finance

Santa Clara University

http://lsb.scu.edu/finance/faculty/Statman/Default.htm


January 1997

January 1997


The story of sharon and russ gornie hopes and fears

The Story of Sharon and Russ GornieHopes and Fears


Gornies clip here

Gornies Clip Here


Standard finance and behavioral finance

Standard Finance and Behavioral Finance

Standard Finance – Investors are rational.

Behavioral Finance – Investors are normal.


We are neither rational nor irrational we are normal

We are neither rational nor irrationalWe are normal

We know Sharon and Russ.

We know their hopes.

We know their fears.

We know their aspirations.

Can we help them?


Promoting the wealth and well being of your clients managing risk regret fear and hope

What do normal investors want?

It is about more than money.

It is about more than risk and returns.

It is about: hope

fear

winningstress

status

security

It is about: life


Financial physicians

Financial Physicians

Physicians promote more than health.

They promote health and well-being.

Financial advisors are financial physicians.

The promote wealth and well-being.

Financial advisors manage investments.

Financial advisors manage investors.


Financial physicians1

Financial Physicians

Ask, listen, empathize

Diagnose

Educate

Treat


First lesson to investors and advisors know yourself

First Lesson to investors and advisorsKnow Yourself

Make yourself your ally

Know your goalsKnow your emotionsKnow your cognitive biases


Second lesson to investors and advisors protect yourself

Second Lesson to investors and advisors Protect Yourself

Make science your ally Know the science of financial markets.Know the science of human behavior.


Third lesson to investors protect yourself

Third Lesson to investors Protect Yourself

Make your financial advisor your allyGood financial advisors are like good physicians.

They educate and sometimes they nudge.

Good financial advisors promote both wealth and well-being.

Third Lesson to advisors

Be a good financial physician


Cognitive biases and emotions rome airport

Cognitive Biases and EmotionsRome Airport


Cognitive biases and emotions rome hotel

Cognitive Biases and EmotionsRome Hotel


Cognitive biases and emotions rome hotel1

Cognitive Biases and EmotionsRome Hotel


Cognitive biases and emotions rome hotel2

Cognitive Biases and EmotionsRome Hotel


Cognitive biases and emotions

Cognitive Biases and Emotions

Cognitive biases

  • Framing

    • Size and color of Euro bills

    • Mental accounting (Where do the €80 belong?)

  • Hindsight

  • Emotions

    • Embarrassment

    • Anger

    • Regret


Cognitive biases and emotions how can we overcome hindsight how can we make peace with losses

Cognitive Biases and EmotionsHow can we overcome hindsight?How can we make peace with losses?

The pain and the phantom pain of regret.


Cognitive biases and emotions regret

Cognitive biases and emotionsRegret

Investors overcome the pain of regret by shifting responsibility.

I am not stupid.

My financial advisor is stupid.


Financial advisors are tempted to strike back

Financial advisors are tempted to strike back.

“If we’re being honest, it was your decision to follow my recommendation that cost you money.”


Cognitive biases and emotions1

Cognitive biases and emotions

Hindsight and regret

Google

Cikovsky took $4,000 cash.

Patterson took 16,000 stock options.

16,000 Google shares

@ $85/share = $1,360,000

@ $300/share = $4,800,000

@480/share = $7,680,000


Cognitive biases and emotions2

Cognitive biases and emotions

Hindsight and regret.

Why didn’t I get my $4,000 in Google options?


Promoting the wealth and well being of your clients managing risk regret fear and hope

Make science your allyCombating cognitive biases and emotionsEducation (We are all subject to hindsight bias and regret) Cikovsky: Do I wish I’d had the shares? Yes…but what’s always in the back of my mind is an IPO is never guaranteed…and 9 out of 10 start-ups fail”


Promoting the wealth and well being of your clients managing risk regret fear and hope

Make science your ally

Evidence – Based Medicine

Theory, hypotheses, and empirical evidence

Wheat Bran Dietary Supplement Appears Not to Reduce Risk for Developing Pre-Cancerous Colorectal Polyps.

New England Journal of Medicine

(2000)


Make science your ally the science of human behavior

Make science your allyThe science of human behavior

But why do we behave as we do?

Because we are intelligent

We search for patterns

We jump to conclusions

We are affected by emotions

We fall into pitfalls of cognitive biases


Evolutionary psychology darwinian psychology

Evolutionary PsychologyDarwinian Psychology

Why is intuition so appealing?

The scientific method as a check on intuition

A brain module for recognizing faces


Recognizing faces clip here

Recognizing faces clip here


Of rats and men who is more intelligent

Of Rats and Men.Who is more intelligent?


Touch a button s or b

S

B

Intelligence - Searching for Patterns

Touch a button, S or B

You win (money or food) if the choice is right.


Promoting the wealth and well being of your clients managing risk regret fear and hope

B

S

Intelligence - Searching for Patterns

Touching Button S

1/5 chance of winning

Always

100%

Rats

4/5

80%

Men

4/5 chance of winning

60%

40%

Make science your ally

Are the patterns you see really there?

20%

Never

0%

1

2

3

4

5

Time


Portfolios and asset allocation

Portfolios and Asset

Allocation


Question

Question

If you could increase your chances of having a more comfortable retirement by taking more risk, would you:

  • Be wiling to take a little more risk with all your money?

  • Be willing to take a lot more risk with some of your money?


If you could increase you chances of improving your returns by taking more risk would you

A lot more risk

=

x

Some of your money

Addition to portfolio risk

=

x

All of your money

Addition to portfolio risk

A little more risk

Money

Risk

a.

If you could increase you chances of improving your returns by taking more risk, would you:

b.


Mean variance portfolio theory

Mean-variance portfolio theory

Investors care only about risk and

expected returns.

Investors are averse to risk.

Investors consider portfolios as a whole.


Promoting the wealth and well being of your clients managing risk regret fear and hope

Mean-Variance Portfolio Theory


Promoting the wealth and well being of your clients managing risk regret fear and hope

Investors are not always averse to riskInvestors buy both insurance policies and lottery ticketsInvestors are motivated by goalsInvestors consider their portfolio as a pyramid of distinct layers, not as a whole

Behavioral Portfolio Theory


Promoting the wealth and well being of your clients managing risk regret fear and hope

Mean-Variance Portfolio TheoryIt all mixes in the stomachInvestors want highly nourishing and low cost meals.

Behavioral Portfolios Portfolios from the perspective of the palate as well as the perspective of the stomach. Investors want highly nourishing and low cost meals. But they also want palatable meals.


Behavioral portfolio theory

Satellite

Core

Behavioral portfolio theory

A LOT more risk with SOME of your money


Behavioral portfolio theory1

Satellite

Core

Behavioral Portfolio Theory

Downside protection vs. Upside potential?

Low risk vs. high risk? (Risk budget)Passive vs. active?Diversified vs. concentrated?


Promoting the wealth and well being of your clients managing risk regret fear and hope

Behavioral Portfolio Theory


Promoting the wealth and well being of your clients managing risk regret fear and hope

Charity

Travel

Children’sEducation

Retirement

Behavioral Portfolio Theory


Behavioral portfolio theory2

I have some chance of upside potential

(20% chance)

I’m virtually sure that my downside is protected

(Almost 100% chance)

Behavioral Portfolio Theory

Different probabilities for

different goals

Financial advisors should create portfolios that distinguish downside protection from upside potential and offer sure downside protection along with some upside potential.


Promoting the wealth and well being of your clients managing risk regret fear and hope

Behavioral Portfolio Theory

Focus on goals


Someone s going to win the lottery just not you it s time for e trade

Behavioral Portfolio Theory

Goals, hopes, fears and aspirations change over time

Late 1990s

Someone’s going to win the lottery.

Just not you.

It’s time for E*Trade


Promoting the wealth and well being of your clients managing risk regret fear and hope

Behavioral Portfolio Theory

Goals, hopes, fears and aspirations change over time

Early 2000s


Promoting the wealth and well being of your clients managing risk regret fear and hope

Behavioral Portfolio Theory

Goals, hopes, fears and aspirations change over time

Late 1990s

Early 2000s

Upside

Upside

Downside

Downside


Financial physicians2

Financial Physicians

Aspirations

Investors aspire to be rich. (Greed)

Investors aspire to be secure. (Fear)

Don’t let your investors fluctuate between greed and fear.

Don’t let your investors fluctuate between lottery tickets and money market funds

Financial Physicians promote wealth and well-being


Make science your ally

Make science your ally

Emotions affect attitudes toward risk

FearTake less risk


Damasio clip here

Damasio Clip Here


Make science your ally emotions affect attitudes towards risk

Make science your allyEmotions affect attitudes towards risk

FearTake less risk

AngerTake more risk

OptimismTake more risk

PessimismTake less risk


Promoting the wealth and well being of your clients managing risk regret fear and hope

Third Lesson for investorsProtect yourself - Make your financial advisor your ally

Good financial advisors are like good physicians. The educate and sometimes nudge.

Good financial advisors promote both wealth and well-being.


Promoting the wealth and well being of your clients managing risk regret fear and hope

Wealth and Well-BeingThe Story of Jim Clark of Silicon Graphics, Netscape and Healtheon(A man with a billion dollars in 1999)


Promoting the wealth and well being of your clients managing risk regret fear and hope

“I just want to have more money than Larry Ellison. I don’t know why.”

Jim Clark of Silicon Graphics, Netscape and Healtheon in an interview with Michael Lewis, New York Times, October 10, 1999.


Larry ellison is rich larry ellison s expenses

Larry Ellison is richLarry Ellison’s expenses

1) Life Style -- annual $20m

2) Interest Accrual -- annual $75m

3) Villa in Japan -- $25m

4) New Yacht -- $194m -- over 3 yrs

5) America's Cup -- $80m -- over 3 yrs

6) UAD -- 12m over 3 yrs.


Larry ellison is rich does larry ellison enjoy well being

Larry Ellison is rich.Does Larry Ellison enjoy well-being?


Promoting the wealth and well being of your clients managing risk regret fear and hope

Larry Ellison’s quest for the perfect yacht began four year ago after a girlfriend slighted his 80-foot sailboat Sayonara.

San Jose Mercury News

July 22, 2000


That s a yacht she exclaimed pointing to a larger white luxury craft floating nearby

“That’s a yacht!” she exclaimed, pointing to a larger white luxury craft floating nearby.


She made me feel terribly inadequate as a result i went on a search to reclaim my adequacy

“She made me feel terribly inadequate,”“As a result, I went on a search to reclaim my adequacy.”


Promoting the wealth and well being of your clients managing risk regret fear and hope

Wealth and Well-Being

Larry Ellison got married


Well being is high when

Well-being is high when:

  • Our positions are high relative to the positions of other people.

  • Our positions are high relative to our own past positions.

  • Our positions are high relative to our aspired positions.


Promoting the wealth and well being of your clients managing risk regret fear and hope

Why are the Danes so happy?On the whole are you very satisfied, fairly satisfied, not very satisfied or not at all satisfied with the life you lead?

Denmark

Very Satisfied

Fairly Satisfied

Not very Satisfied

Not at all Satisfied

Don’t Know

EU


Life satisfaction happiness scale

Life Satisfaction (Happiness) scale

Why are Danes so happy?

Danes have low expectations from life

Danes’ life exceeds expectations

“And in 1992 the Danes won the European Championship in soccer, creating ‘such a state of euphoria that the country has not been the same since.”

NYT, January 1, 2007


Conclusion

Conclusion


Promoting the wealth and well being of your clients managing risk regret fear and hope

First LessonKnow yourself - Make yourself your ally.Second LessonProtect yourself - Make science your ally.Third LessonProtect yourself -Make your financial advisor your ally.


Promoting the wealth and well being of your clients managing risk regret fear and hope

Life Satisfaction of AdvisorsEmail from Larry Ellison’s AdvisorReduce the concentration of Oracle in your portfolio.

  • "I know this e-mail may/will depress you.

  • However, I believe it's my job to address issues you'd prefer not to confront.

  • You told me years ago that it's OK to raise the 'diversification issue' with you quarterly. ...

  • Well, I'm doing so.

  • View this as a call to arms."


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