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Dr. Randy McIntosh , Senior Scientist and Associate Director, Rotman Research Institute and professer at U of T points to scans of brains that are displayed on a computer screen. The different colours represent different cognitive functions of the brain. (FRED LUM/ GLOBE AND MAIL/FRED LUM/ GLOBE AND MAIL)
Dr. Randy McIntosh , Senior Scientist and Associate Director, Rotman Research Institute and professer at U of T points to scans of brains that are displayed on a computer screen. The different colours represent different cognitive functions of the brain. (FRED LUM/ GLOBE AND MAIL/FRED LUM/ GLOBE AND MAIL)

An investor's worst enemy? Their brain Add to ...

Ritholtz describes Fusion IQ’s moves throughout the fall as a supreme test of his company’s determination. After the firm sold its volatile technology, emerging-market and small-cap stocks at the beginning of August, the S&P 500 dropped almost 15%. Beginning in October, however, there was a five-day rally, and the firm decided to buy back into some of the small-cap names it had dumped. “It had a nice run,” Ritholtz says. “It ran up another 10, 11% from there, and up to 1,300 [in the S&P 500]or so. And then started heading back, and it came right back to the level where we bought, and it was heading through it, so we sold. We basically said, hey, this was a fake breakout, so if we can get out at a break-even and not suffer the drawdowns, we’ll be happy.’”

Even though he says “the gut instinct is, ‘I gotta get me some of this; jump in!’” Ritholtz stands by the strategy he hatched in less emotional times. “I call that the prenup. When you’re first engaged, everybody’s happy and it’s unthinkable that it won’t work out, but at least you know everyone’s objective, you’re not throwing plates and there’s no emotion. You buy any asset class, any equity, you buy anything—you make a decision at that moment, while you’re still objective: ‘Hey, if it does this, this is where I get out.’”

Strategies to combat the emotional turmoil brought on by loss aversion, the natural cognitive disinclination toward any kind of loss, are even finding their way into the sell-side world. Insurance and wealth management titan Allianz has launched its own Center for Behavioural Finance, whose website features a white paper by UCLA professor Shlomo Benartzi that recommends advisers adopt what he calls the Ulysses Strategy, namely having investors and advisers draw up a “Commitment Memorandum” whereby they agree in advance what action would be taken in the event of market moves of, say, 25% in either direction. The agreement is legally non-binding, but it does encourage investors to resist being swayed by loss aversion, particularly in turbulent markets.

For all the doom and gloom about our mental shortcomings, behavioural economics does provide us with one reassuringly universal caveat: that no one is exempt from these irksome biases. You, me, Ben Bernanke and the rest of the human race: We’re all in it together.

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Face value: Digitally aged pictures cause people to save more for retirement

If you have trouble conceiving of the financial needs of your older self, you’re not alone. Studies show that the part of the brain that lights up when people think about themselves in retirement is the same one that is activated when they think about a stranger. To bridge the gap, a team of researchers at Northwestern University, led by Hal Ersner-Hershfield, have developed digital imaging techniques that show prospective savers what they will look like at retirement age. Seeing themselves years later significantly increased their willingness to commit more money to retirement savings, as did changing the image so that the face was smiling. Insurance and wealth management giant Allianz is now developing a scaled-down version of the technique for its financial advisers to use.



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