As featured in The Wall Street Journal, Money Magazine, and more!

Posts tagged as:

People

Add a comment

Email this article Email this article
Print this article Print this article

Quick Survey: What Drives Your Trading Decisions?

by Flexo on November 3, 2009

in People

This is a guest article by Scott Treadwell, a long-time Consumerism Commentary reader and graduate student at the University of New Hampshire. Scott is studying finance and is conducting a study in behavioral finance. Please look for the survey below and help Scott conduct his study.

We are only a year removed from the greatest financial crisis that has been seen since the Great Depression, and many voices have vowed reform throughout the industry and have assured us that these events would never happen again. The world of academia, however, needs to catch up to reality. As our engine of intellectual innovation, they should be on the cutting edge, but the same flawed precepts that have been taught to our business and finance students over the past twenty years continue to be taught (although the smart instructors will deliver the material with a caveat).

The standard methodology has been the Efficient Market hypothesis. Since news and information is so prevalent, academics assume the massive army of savvy investors that are active in the financial markets will instantly price the stock at the appropriate value. Given that assumption, most variables in the financial markets including human error are factored out and statistics are easily utilized to measure risk.

However, factoring out the human element was a mistake. Humans are the actors who analyze stocks and choose to buy, sell, or hold, thus determining the stock price. This is true whether the investor is an individual trading in her own account or a manager of a large mutual fund or trust. Based on recent events, it became clear that these three key assumptions surrounding efficient markets were incorrect:

  1. Prices DO NOT reflect all available information. Not all information that is acted upon is available to the public. Frequent and chronic insider trading nullifies this effect. The problem is not just Wall Street; corporate executives and employees with a shareholder interest in their own company can, and do, cash out before unfavorable information becomes public, although few get caught.
  2. Public information IS NOT always interpreted correctly. For example, many companies’ exposure to Mortgage Backed Securities was clearly stated in their financials, however that was determined to not be a problem until default rates skyrocketed. Some in the financial community warned that the level of risk was being underestimated for years, but inertia trumped their few voices and valuations remained unchanged, and wrong.
  3. Human Beings are NOT rational actors. Many precepts of economics are based on the assumption that the average human will optimize his economic interest at any given time by making the optimal decision. If this were the case, impulse consumer buying, groupthink, and stock market booms and busts would never happen. This is like saying that when there is a fire in a crowded theater, people will calmly line up in the reverse order of their seating arrangement and orderly file out of the building because they know this behavior is in their best interest. The concept sounds ludicrous in that context, so why is it applied to financial markets? People panic due to fear, they over-extend themselves due to greed, and they make foolish decisions. In other words, they behave like humans, not robots.

Enter the field of behavioral economics and finance, one that has been on the fringes of academia for many years. Once viewed as a disparate group of contrarians who analyzed strange aberrations in the market, their work was discounted by mainstream. However, in light of recent events, academics and investors are paying new attention to this field and the body of research conducted over the past several decades.

So what is behavioral economics? Essentially, it is study of trading behavior that is not rational. The trading behavior of humans is analyzed to gain insight about financial markets and to account for deviation from normal behavior. Here are some examples of these unique trading patterns:

  • emotional or vested attachment to stocks
  • panic selling and impulse buying
  • recency effect (you are more quick to sell a stock you just bought rather than one you have owned for awhile)
  • disposition effect (people are more willing to sell stocks that increase in value and hold the stocks that decrease losers)

Now the next question is, why do you care? Accepting where we went wrong is the first step, however everyone from finance professors to Wall Street professionals need to understand how the forces in play that can shape the investment environment now and in the future. If non-rational human behavior is truly a large factor in the market, we need to be aware of it and consider it as we formulate our individual investment strategies.

In order to gain some more insight about individual behavior, I have a quick survey about your trading habits. It’s quick, easy, and totally anonymous. The goal is to gain as much input as possible. Five minutes of your time will yield great results which I will be happy to share with Consumerism Commentary readers once the data and reports are available.

Please complete this anonymous survey.

Editor’s note: I completed the survey in under two minutes. Please take a moment to complete the short questionnaire and help Scott, a graduate student, complete his research study and earn his Master’s degree. ~ Flexo

{ 0 comments }



6 comments

Email this article Email this article
Print this article Print this article

Investor Psychology: Why We Fail to Make Good Financial Decisions

by Flexo on October 21, 2009

in People

Investors make better decisions when they separate emotions from the thought process, but it’s practically impossible to achieve the goal in perfection. Regardless of how hard one tries, emotions will always be present. The best an investor, or anyone who makes decisions about finances, can achieve is awareness of the ways psychology prevents optimal decision making.

I took Kiplinger’s new investor psychology quiz, which focuses on the ways investors’ brains work against us as we try to make solid investment decisions. I answered seven of the eight questions correctly. The quiz was a good reminder of the brain’s subtle ways of changing perception and understanding of a situation.

Here are some interesting aspects of psychology that hinder the best decision-making.

Recency effect

We tend to remember better events that happened most recently. While at the peak of a bubble, like we’ve seen in real estate and stocks, several years of increases hide the reality that bubbles burst when high prices are not supported with fundamental value. Likewise, if you are asked to review your experiences at a restaurant, even if you have visit that restaurant for decades, your most recent experience at that venue will have the most weight.

Here’s how this can damage you: In the midst of a recession, it seems like the stock market keeps getting lower. All we see is bad news like financial scandals and corruption. We forget that over the long term, the stock market has been the best way to grow your money. So we abandon the stock market and miss out on those gains when the economy rebounds.

Confirmation bias

There are certain things we want to believe. Several years ago, a friend told me that “real estate always goes up.” There’s the recency effect again. Also, to believe that any investment can’t fail, we must ignore information that does not fit in with that philosophy. We seek out the studies or opinions that match our own as we look for confirmation.

Here’s how this can damage you: If you are looking to buy a house, it would be smart to look for reasons that the purchase will be financially sound over the long term. You will cite the usual positive aspects of home purchasing, including the fact that it’s an asset likely to appreciate and you receive a small tax break on mortgage interest, but you’ll likely ignore the fact that you’re likely to move out of the house before buying gains its advantage over renting.

Losing money is painful

The brain reacts to losing money the same way it reacts to pain. As pain is something we are built to avoid, we also try to avoid any potential for losing money. On the surface, this sounds like it would be a good thing, producing decisions that are more likely to side with gaining rather than losing. What really happens is that if we are presented with a situation where we have an even chance of winning $150 or losing $100, we won’t take the chance.

Here’s how this can damage you: The fear of losing money and experiencing the associated pain will keep us from taking risks. For people invested in the stock market, the pain experienced when reading those quarterly statements with negative returns causes many to sell at the wrong moment. They’ll miss out on the market’s rebound. While the stock market has a great track record over long periods of time, if you’re only invested when the market is decreasing, your performance will never match the stock market.

Want more? Here’s a list of cognitive biases. Just about everything pertains to financial decisions in some manner.

Photo credit: Martin Pettitt

{ 6 comments }



16 comments

Email this article Email this article
Print this article Print this article

Men Paying for Dinner: Is It More Romantic?

by Well-Heeled on September 2, 2009

in People

This is a guest article by Well-Heeled, creator of the blog Well-Heeled, With a Mission. If you enjoy this article, subscribe to her blog using her RSS feed.

Last week, boyfriend picked me up at my apartment. I dressed up in a red dress and put on sparkly earrings. We went to one of my favorite restaurants and ate by candlelight. It was a lovely night and romantic night, but is it wrong to say that boyfriend paying definitely upped the romance factor?

Maybe I’ve been “socialized,” (oh society and its expectations about the financial aspect of love and dating) but there’s something inherently more romantic when the man pays for dinner than when the couple goes splits on the bill. At first, I felt slightly guilty about that. After all, why should the man paying be more romantic?

I’ve been raised to be a financially independent woman. I read a lot of history and nonfiction books that discuss the intersection of love, money, and power. Maybe that’s why when I was in high school, I was always uncomfortable with guys — even friends — treating me to dinner. As I’ve grown older, though, I’ve realized that sometimes, I should just stop analyzing everything.

Boyfriend and I take turns paying for things or we split it down the middle. I think it all evens out at the end. But last evening was a real, old-fashioned date. And, according to real, old-fashioned romance protocol, he opened the door, pulled out my chair, and paid for the dinner.

Most of my girlfriends agree with me: The first date, the guy pays. The dates after that, couples will take turns paying or split the check. Or perhaps, one party will pick up the check for the dinner and the other will pay for the movie tickets. Whatever the arrangement, I’ve discovered that the most important thing is that neither side feels like they’re mooching or taken advantage of. And if boyfriend paying for a special dinner makes the night seem more special, well, I suppose I don’t have to beat myself up for it.

I’m not giving up my “independent woman” card. I can support myself, yes, but I hope I’m never so independent that I can’t let a little romance in my life.

{ 16 comments }

6 comments

Email this article Email this article
Print this article Print this article

Thinking is Not Enough

by Frank Curmudgeon on June 2, 2009

in Economics

This is a guest article by Frank Curmudgeon, author of the Bad Money Advice blog. For updates from Frank, subscribe to the Bad Money Advice RSS feed.

We often see the struggle to get control of our spending as being the conflict between our emotional and logical selves. Emotion wants to go out to that new restaurant tonight, logic says cook at home.

We say to ourselves “If only I could stop and think about all my spending decisions, I’d soon be rich.” That’s not wrong, exactly, but it makes at least one big faulty assumption, that it is easy for us to be logical around money when we want to be. The truth is that just thinking about it is not always enough.

There is an entire field of economics, behavioral economics, which studies the differences between what logic would have people do with their money and what they really do. The academics in this area have collected many such “anomalies.”

Mississippi River

One that illustrates well the illogic of our thinking selves is anchoring, the tendency for people to be influenced by even the most ridiculous estimates of a number. The classic example is that if you ask people if the Mississippi is more than 6000 miles long and then ask them to guess its exact length, they will give much higher guesses than if you had just asked them to estimate its length. (It is 2340 miles long, by the way.)

Dan Ariely, a professor at MIT/Sloan, conducted a striking demonstration of this effect. He asked a group of MBA students to write down the last two digits of their social security number. Then he asked them if they would be willing to pay that amount of dollars for a bottle of fine wine he was holding. Finally he had them submit actual bids for the wine, which he really sold to the winner.

Sure enough, the students tended to bid higher if they had social security numbers that ended in higher digits. So the anchoring effect was there even though the participants were fully aware that the suggested value was completely random, even though they were sophisticated and thoughtful (have I mentioned I got my MBA at Sloan?) and even though it was their own real money at stake. This was not an impulse decision in which consumers let emotion get the better of them. These were would-be shrewd businessmen who undoubtedly assumed that Prof. Ariely was up to something sneaky.

And anchoring explains a few oddities in our everyday lives. It is why houses, cars, and jewelry often have high “asking” or “sticker” prices. The seller does not really expect to get this price and the buyer does not expect to pay it. So why bother? Because by attaching a tag on a watch that reads “$500″ the jeweler can more easily talk you into paying $425, even if you know full well that the $500 price was just for show.

And anchoring also helps explain some stock price movements, specifically the phenomenon called price momentum. That is the tendency for stocks that have been going up over the past few months to continue to do so.

Imagine that there is an exciting growth company that announces some positive news when its stock trades at $50. There is a large group of investors who love this company, are excited by the news, and would, in principle, pay $100 a share. However, because of anchoring, they just cannot bring themselves to pay more than $10 above what the stock was trading at in the past month. It just seems expensive. When the stock goes above that level these buyers back off, temporarily. After a few weeks, the current price does not seem so unreasonable, because they get used to it, and they resume buying. The result is that even though in a more logical environment the stock would have gone to $100 immediately, what actually happens is that it climbs steadily at about $10 per month over five months.

It’s important to understand that anchoring doesn’t happen because you are stupid, or too emotional, or overly influenced by advertising. It happens because you are human. It is the way your brain is wired up. You can’t stop yourself from doing it, although being aware of it is a great help.

The point is that merely resolving to think about how you spend is not enough. Spending logically is harder than it looks.

Photo credit: Don3rdSE

{ 6 comments }

1 comment

Email this article Email this article
Print this article Print this article

Podcast 2: Recession-Proof Your Relationship and Mint’s New Features

by Flexo on May 3, 2009

in Podcast

In today’s podcast, Tom Dziubek talks with Dr. Bonnie Eaker Weil about ensuring your marriage or relationship survives the recession. Tom also talks with Aaron Patzer, CEO of Mint, about the new financial advisory features released to beta testers.

 
To listen, use the player above (Adobe Flash required), download the podcast here, subscribe to the podcast RSS feed, or use the iTunes link.

[00:00] Introduction from Flexo
[00:41] Interview with Dr. Bonnie Eaker-Weil about how to recession-proof your relationship
[03:12] — Keeping money talks under 10 minutes
[06:41] — The childhood development of financial belief sets
[09:00] — Marital stress issues on the rise since the October market collapse
[12:23] — When new couples should start talking money
[16:14] — Dr. Bonnie wrap-up
[17:16] Interview with Aaron Patzer, CEO of Mint.com
[18:30] — Security at Mint.com
[22:31] — Mint.com vs. Quicken
[24:20] — New financial features at Mint.com
[27:55] — Instructions on how to get a new feature beta account via Consumerism Commentary
[28:15] — How Mint.com makes money from affiliates
[30:42] — Aaron Patzer wrap-up
[31:25] End

If you have suggestions for the next edition of the Consumerism Commentary Podcast, or reactions to these interviews, feel free to leave a comment here or email your thoughts to podcast at this domain name.

{ 1 comment }

2 comments

Email this article Email this article
Print this article Print this article

Knowing Your Financial History is Crucial to Your Future

by Flexo on April 15, 2009

in People

About the author: This is a guest article by Dr. Bonnie Eaker Weil. Dr. Bonnie was named by New York Magazine as one of the city’s top therapists. Her most recent book, Financial Infidelity, was released in paperback edition on March 31.

Whether or not you’re specifically struggling with money in your relationship, one thing can’t be denied: it’s a hot-button issue, and one that most people can use a bit of help with. One of the best and biggest things I believe a couple can do is construct what I call a “Money Gram” — or a money family tree. This helps couples to understand each other’s attitudes, fears, beliefs and patterns in both families’ money histories. It’ll help give you a heads-up on what could produce potential conflict, or explain why you’ve been having trouble in certain areas.

You need to ask yourselves such important questions as:

  • “How was money handled in my family?”
  • “Was I aware of any financial troubles as a kid?”
  • “How did this affect my view of money?”
  • “Was money used as punishment or reward?”
  • “How has this influences my finances as an adult?”

These are some topics to get you started — I discuss many more in Financial Infidelity -– and you should have no trouble coming up with more on your own, once you get started! You may know the answers to these questions for yourself, but knowing your partner’s answers as well is almost equally as important if you’re going to move on from a power struggle that often exists around love and finances.

Then, integrate this with what I call “the money love language” — which I teach in Make Up, Don’t Breakup — i.e. giving each other a safe place to be honest about your fears (both financial and otherwise) and using a communication style that affirms where each person is coming from. By doing this, you can slowly begin to erode the stigma that money often creates. It’s absolutely crucial that this stigma be done away with in an intimate relationship, if that relationship wants to move forward. Often couples mistake a lack of communication about finances for a lack of compatibility, but integrating a few of these tasks and dialogues can prove that’s not true!

Another important tip in the compatibility of a relationship is to make sure you fight fair. Have a ten minute heart-to-heart weekly with a figurative emotional “bullet proof vest” to protect from hurt, anger and defensiveness, as you listen and echo back what you heard. It is essential to walk in your partner’s shoes rather than trying to be right. Instead of shame and blame you should give three solutions, and your partner has to pick at least one. Fighting fairly creates the tension that gives you passion and makes you feel safe.

If you enjoyed this article, please visit Dr. Bonnie Eaker Weil’s blog. You can also subscribe to the blog’s RSS feed. We would appreciate your comments and reactions, so if you would like to contribute to the discussion, add your comment below.

{ 2 comments }

8 comments

Email this article Email this article
Print this article Print this article

A Home of My Own: Why We Buy

by Flexo on April 13, 2009

in People

About the author: This is a guest article by Matt Wallaert, a behavioral psychologist and the Lead Scientist at Thrive, a free financial advisory website that helps people organize their finances and plan for the future with personalized feedback from its behavioral advisory engine.

I’m an owner. While I rent an apartment in New York City (the average apartment in Manhattan is worth $1.5 million; I won’t be buying soon), I’ve never leased a car or rented my furnishings because, generally speaking, I simply prefer to own than to buy.

But with the mortgage meltdown and the recent issues surrounding overconsumption, home ownership is becoming an active question, rather than the default standard. Rebecca Tuhus-Dubrow wrote a piece for The Boston Globe recently summarizing the debate and the angle was clear: homeownership needs rethinking, and is probably dramatically less good than we think it is.

I liked the article and a number of interesting academics weighed in to contribute, but the focus was on the social impacts of owning, rather than the personal ones, and I think that misses a key part of the equation. How we feel about owning versus renting, and how it changes our behavior, is worth exploring, particularly as owning wins in some unusual ways.

I should be clear that I’m not trying to argue that owning a home is intrinsically better than renting an apartment. As Tuhus-Dubrow points out, many of the disadvantages of a home rental are due to inadequate legal protections, rather than the actual rental procedure itself. Instead, my concern is with the psychological consequences of owning versus renting in general, whether it is an apartment, or a car, or a computer. I’m going to talk about apartments, just because they make a handy example, but feel free to insert “leased car” if it makes you happy.

Consider the typical renting New Yorker in their mid-20s. Few would argue that looking for an apartment is pleasant, and most would label it down around the 5th or 6th circle of hell. You have to find a place you can afford, that you like, that accommodates your lifestyle, that is in the right location, and is decently hard to do, given the actual raw number of rentals available in any given area.

Assuming you manage to actually find a place you like, you then have to actually get it, which can be harder than it sounds when people are going on and off the market at lightning speed. Renters live in a constant state of indecision: should I put a deposit down on this place now? If I take two minutes to talk myself into believing that it is the perfect place for me, will it be snatched away, leaving me with only the certainty that it was the best of all worlds and now I can never have it? Few people enjoy the process and fewer still come out feeling “happy,” and it is no wonder: a home is supposed to make you feel permanent, not dissatisfied.

And yet renters go through the process again and again, year after year. For many, it isn’t a choice: as Tuhus-Dubrow points out, renters don’t enjoy all that many legal protections and many of them get priced out or forced out of their housing, throwing them back onto the market. But even for those that could stay, many of them don’t because of the torture of knowing that you could have something different. Because you can move, you want to – knowing that other options are out there, it is part of our personal psyche and our national culture to want to explore them.

The problem is that psychologists have shown fairly conclusively that this type of comparison is almost certain to make you unhappy. The more options there are to consider, the more time you spend thinking about them, the more difficult the decision, and the more regret you feel when you actually pick one. And renting means always having options: there is always another apartment you could easily take, another car you could easily drive.

Owning alleviates this problem. While you can still compare your home to others (and many people do move several times over the course of their lives), increasing your attachment an object makes it harder to let go of and increases its value in your mind. Psychologists call it the endowment effect and it breaks down simply: there is value to feeling like something is “yours.” And while we can certainly think of our apartments as part of our domain in a psychological way, there are plenty of reminders in daily life that we don’t own them and never will.

And it isn’t just mental. The psychological value of owning translates to real value in your interactions, as almost anyone that has ever rented something intrinsically knows. You scratch the floor and don’t feel particularly bad or try to get it fixed (unless motivated by worry about your damage deposit). You beat the hell out of a computer until the lease runs out and you get a new one. No one puts premium gas in a rental car.

A home is a decision you don’t have to make again, or at least not for awhile. And there is value, sometimes, in less: less comparison, fewer decisions, less movement. Even as renting and leasing allow us to maintain our flexibility, they demand that we give up any number of psychological benefits. Sometimes it is a good trade, but more often than not, our instinct towards ownership is probably a decent one. Especially when it lets us save our time and energy for the decisions that matter; less “where will I live tomorrow?” and more “what will I do today?”.

If you enjoyed this article, please visit Thrive and Thrive’s blog, Good to Grow. You can also subscribe to the blog’s RSS feed. We would appreciate your comments and reactions, so if you would like to contribute to the discussion, add your comment below.

{ 8 comments }

3 comments

Email this article Email this article
Print this article Print this article

Emotions and Money: When to Keep Them Separated

by Flexo on October 20, 2008

in People

Human beings aren’t logical, and it doesn’t take a scientist from Vulcan to prove that fact. A corollary to this statement is that human beings do not make logical decisions when it comes to their personal finances. Consider some things that could happen if people thought about the financial consequences of every choice:

  • People would save a greater portion of their income, creating havoc for retailers.
  • Consumers would buy only what they need, destroying the market for luxury items.
  • The Joneses wouldn’t have anyone following them and might die of loneliness.
  • Families would not have children, savings hundreds of thousands of dollars.
  • Environmentally conscious options more expensive than the alternatives will not be pursued, causing the planet to eventually perish (sooner than otherwise).

Thankfully, people do not base all decisions on financial rationality alone, and thus our economy, species and planet continue to survive and thrive, although the economy has been taking a beating recently. Emotions and money are linked, but there are some instances when an individual will be better off by separating the two as much as possible.

Investing during a highly-volatile market. Your asset allocation should relate to your time horizon, not react to the current hype in the news. If you had decided that you could withstand short-term market plunges with the goal of a long-term gain through stock market investing, don’t let fear and panic dictate changes when the market dives.

Evaluating products and services. Advertising and marketing are important. This is how a company gets information about its products and services to the public. Every year, the advertising industry advances further, using scientific research that explains how emotions are tied to everyday decision making.

The commercials that you see on television are developed specifically to influence shopping decisions. Even non-profit organizations use your emotions to their advantage; how many times do you see commercials for charities using videos of children who appear to be malnourished and obviously in need of help?

Chances are we’re being marketed to in ways we are unaware. Product placement in television programs in passé, now even presidential candidates are advertising in video games. This is a game the consumer can usually not win. Thankfully there are resources that help us see through the marketing noise, such as Consumer Reports, Charity Navigator, and GuideStar.

Getting out of debt. If you’re in debt, there’s a chance that your emotions led you there. While it’s true that many people are in insurmountable debt due to circumstances beyond control like a medical emergency or a natural disaster, a good portion of people are in debt because they enjoy spending money without thinking about or understanding the financial circumstances.

Some authors and radio show hosts want to have these people get out of credit card debt by playing to their emotions, the cause of debt in the first place. This only solves a short-term symptom, the debt, rather tan the underlying problem, spending decisions based on emotion. It is likely that someone who lets their emotions control their spending as well as their path to reduce their debt will fall back into debt later on. This is why I suggest the “Debt Avalanche” method of getting out of debt. It helps separate emotions from your decisions, a pattern than will help keep you out of debt once you reach that point.

Purchasing a house. I wrote recently about ten tips for buying a house in any market. Ron from The Wisdom Journal wrote in with this comment: “One thing I would add, and it’s very difficult to do, but try to take emotion out of the buying process and especially the negotiation process. Emotions can cause you to pay too much and make a decision that you’ll later regret.”

You want to live in a house that you will like, preferably for a long time. That has to be a part of your decision making process. If you plan in spending a lot of time with this major purchase, it should very well be with a product that makes you happy. The danger comes in the belief that that particular house may be the only one for you. You might fall in love at first sight with your soul mate, but a house is just a house. Don’t get so caught up that you feel you must have the house at any cost and be willing to pay any price to get it.

A better understanding of how your emotions are involved with money is a key to overcoming the influence for certain important decisions as much as possible. Here are a few articles that could help.

When It Comes to Money, Emotions Run High, Psychology Today. “Despite our best efforts, economic decisions can be influenced by emotion. Researchers offer a neurological explanation: The part of the brain that controls negative thinking can often override logical thought…”

The Psychology of Money (series), PsyBlog. “Until recently social scientists didn’t know much about the psychology of money. That has changed with an explosion of fascinating findings on how it affects our emotions, our personalities, our sexual behaviour, our risk-taking and society at large…”

How to Treat a “Money Disorder”, Sarah Kershaw, The New York Times. “Among the problem financial behaviors identified by psychologists in recent years are: overspending, underspending (aka Depression mentality), serial borrowing, financial infidelity (“cheating” on a spouse by spending and lying about it), workaholism, financial incest (lording money over relatives to control them), financial enabling (throwing large sums at, say, adult children who then are not motivated to support themselves), hoarding, and plenty of guilt and shame around poverty and wealth…”

Emotions are intricately linked with the financial decision making process, and are in fact necessary to make the correct choices in many situations. Even a small effort to put feelings aside in certain circumstances and think rationally could go a long way towards improving the quality of those decisions.

{ 3 comments }

Page 1 of 212Earlier Articles »