The Implications of Behavioral Finance

Asset allocation, risk, diversification and rebalancing. Pros/cons of hiring a financial advisor. Seeking advice on your portfolio?
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ghariton
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Post by ghariton »

Yes. The EMH is untestable and cannot be relied upon. Anomalies exist, but unfortunately they are subject to going away without notice. Even when they persist, exploiting them can be very risky, as shown by the experience of LTCM. So as an investor, I am left with two possible approaches.

(1) Study a sector or a firm to death, in hopes of understanding it better than the market does. In particular, I have to understand it better than analysts who are paid from several hundred thousand to over a million a year to understand it better than me. So I have to outguess these analysts. Or I have to head to those stocks that are thinly or not covered, and I have to find out about them in some way. Sounds like a full-time job. And when I tried doing it in 1999-2000, I failed abysmally.

(2) Accept my ignorance and spread my bets as widely and thinly as possible. That way I will pick up my share of positive and negative anomalies, and anything else going around. In particular, an Enron will not hurt me. (I am abstracting from the relatively thin Canadian equitiy market.) Oh, and do it in such a way as to minimize costs.

I'm sorry, but I just don't believe that the ordinary investor can exploit the findings so far of behavioural finance. For every anomaly or irrational behaviour going one way, there seems to be another suggesting I act in the opposite direction. Instead of a paucity of explanations, it has an over-abundance, with no way of sorting out which ones will be relevant in the future.

But fascinating reading for its entertainment value. :lol:

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Post by yielder »

ghariton wrote:Anomalies exist, but unfortunately they are subject to going away without notice.

Not picking at you here but can you list those that have.
In particular, I have to understand it better than analysts
A fairly low hurdle according to David Dreman and Michael Berry. in "Analyst Forecasting Errors and Their Implications for Security Analysts." Financial Analysts journal, May/June, 1995, pp. 30-41.
Sounds like a full-time job.
There's no doubt that a lot of time is involved if you are going to be organized and systematic about it although there are ways to reduce the time dramatically.
For every anomaly or irrational behaviour going one way, there seems to be another suggesting I act in the opposite direction.
Again not picking at you here but what specifically do you have in mind?

Instead of a paucity of explanations, it has an over-abundance, with no way of sorting out which ones will be relevant in the future.
Hmmm, if low p/e and low p/b stocks which are generally held in low esteem become winners over long periods as academics and some practioners have demonstrated, what more sorting do you need? If you're concerned that low p/e and low p/b stocks include a lot of last gasp stocks or a lot of small caps, then select stocks with strong balance sheets as evidenced by "manageable" debt, say <50%, a long history, ie, multiple economic cycles, of steadily increasing earnings, preferably smooth. And diversify by the number of holdings and across industries, even across borders.

Or work from a quality universe such as S&P's Dividend Aristocrats or S&P's A+ (Earnings/Dividend Quality Stocks), ie, piggyback on some fairly strong research and buy 'em when they are relatively cheap. Brandy might like these.
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Post by parvus »

yielder quoted:
Then Fama completely disregards Friedman, and of course all philosophers of science. He argues that, in order to dispose of the EMH, an alternative model that better explains "... price information, itself potentially rejectable by empirical tests," should be formulated, before one is to entertain the disposal of the current hypothesis.
I wonder why the author relies on Kuhn and doesn't look at Popper's falsifiability criterion, in which case Fama should provide the grounds, not a competitor: in other words he should specify what would disprove EMH. Then there's Lakatos's more conciliatory approach to theory-testing, and Fama could just say he's involved in a research program that involves some ad hoc models that are conducive to future research (which, after all, are what strong, semi-strong and weak EMH are). In any case, economics isn't "science," since it's not studying immutable laws of nature, but rather conditional sequences of human behaviour, or "emergent properties" that are quite changeable, even if they dominate over a period (think of Milton Friedman and inflation expectations: if people expect more inflation, that's the way they buy, invest and bargain for wages; when the expectation changes, then so too does the behaviour, regardless of what the central bank is actually up to).

On the one hand, I find behavioural finance fascinating; on the other, I find it is an amusing example of what happens when financial economists step back from logical proofs and actually look at what's happening in the other human sciences, and by extension, (albeit indirect, since the human sciences are ridden with jargon and self-aggrandizing mischief too) the real world — to wit, that Miller-Modigliani doesn't apply in practice. Firms may be indifferent to dividends versus buybacks versus retained earnings, but investors aren't.

Someone noted on the Ford thread that as it cut its dividend to zero, the stock flopped 11%. Not much faith in the interchangeability/fungibility of retained earnings there. :lol:
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Post by yielder »

parvus wrote:I wonder why the author relies on Kuhn and doesn't look at Popper's falsifiability criterion
He does but the article is under lock and key and it was a tough one to fairly cherry pick.
On the one hand, I find behavioural finance fascinating
Yep. I've been mucking around chasing BF stuff today and came across a couple of excellent essays that try to step back and put the financial economist/behavioural economist fight in perspective.

An apparently disinterested party and a combatant who is part of a call-to-arms.
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Post by parvus »

yielder cited:
''When we gave this paper at Berkeley, someone said that we had developed a terminology that bridged economics and sociology,'' Mr. Akerlof said. ''The sociologists already knew all this and now we are putting it in a framework that economists can understand.''
I hadn't expected it to be stated so baldly. I once saw Thaler give a speech (mostly about how workers divide their money in equal dollops among every fund their employer offers in a retirement plan, regardless of the efficient frontier, even Harry Markowitz in his TIAA-CREF holdings). Then I read Shiller's Irrational Exuberance in 2000. As someone who spent a few years TAing first-year social psych, I thought his 12 behavioural digressions were a little obvious, and needed to be better organized.

The paragraphs on Bowles and Gintis were intriguing too. Now if we could just get the discussion from capital (and how it's not being reinvested, as one CAW economist constantly laments) through human capital (highly educated skateboarder dudes) to social capital (skateboarder dudes without the 'tude who give back to the community, and not through disembodied United Appeal checkoffs but by mentoring).... :roll:

Lest you think this tetchy, my reference on the latter is Putnam's "Bowling Alone." That, combined with Freakanomics, might provide some insight into why Little Portugal, for example, mostly works while Jane-Finch mostly doesn't. It's not quite about more government money, nor is it quite about individual ambition, but something else, perhaps community capacity. (Once a grad student....) :wink:
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ghariton
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Post by ghariton »

yielder wrote:
ghariton wrote:Anomalies exist, but unfortunately they are subject to going away without notice.

Not picking at you here but can you list those that have.
I don't mind being picked at, if it is done in good faith. :)

The best example of what I have in mind is the January effect, which was quite powerful until it was popularized. I understand that it is pretty well indiscernable now.

In particular, I have to understand it better than analysts
A fairly low hurdle according to David Dreman and Michael Berry. in "Analyst Forecasting Errors and Their Implications for Security Analysts." Financial Analysts journal, May/June, 1995, pp. 30-41.
Fair enough. I set myself up for that one. But I think that there are people out there who know more than I do about every conceivable investment opportunity. I don't think I can beat them.

The argument may be that there are not enough knowledgeable investors out there to handicap me. But that, in itself, is quite a risk.
For every anomaly or irrational behaviour going one way, there seems to be another suggesting I act in the opposite direction.
Again not picking at you here but what specifically do you have in mind?
As an example, on one theory, investors tend to over-react to news (due to the availability heuristic). But they tend to under-react to news. (This is due to over-confidence, combined with anchoring.)

For an example that is closer to home for me, consider RRBs. Studies of framing suggest that the average investor is much more loss averse than commonly thought. So the premium that purchasers of RRBs should be willing to pay to avoid the risk of unexpected inflation should be very high. A 1% real return should be fine for them. But we also know that investors suffer from fear of the unfamiliar, and thinking in real (as opposed to nominal) terms is definitely unfamiliar for most (including some on this forum). So they will require a higher real return than otherwise justified to induce them to purchase RRBs. So a 2% or 3% real return rate might be the "right" level.

So with RRBs at about 1.7% currently, is that too high or too low? Depends which behavioral finance chapter I just finished reading.

Instead of a paucity of explanations, it has an over-abundance, with no way of sorting out which ones will be relevant in the future.
Hmmm, if low p/e and low p/b stocks which are generally held in low esteem become winners over long periods as academics and some practioners have demonstrated, what more sorting do you need? If you're concerned that low p/e and low p/b stocks include a lot of last gasp stocks or a lot of small caps, then select stocks with strong balance sheets as evidenced by "manageable" debt, say <50%, a long history, ie, multiple economic cycles, of steadily increasing earnings, preferably smooth. And diversify by the number of holdings and across industries, even across borders.
I certainly won't argue with the diversification portion of your advice. :)

The problem with the rest is that (1) you must believe that the accounting numbers are a fair representation, when we know that it can take months for management and auditors to agree on the wording of a note to the financial statements, so that it obfuscates enough without opeing the auditors up to liability, and (2) trends tend to change unexpectedly -- you never know whether you are riding a parabola or the crest of a sine wave.

Anyway, I note that you seem to use behavioural finance to discredit some of the traditional finance theories (I agree), but not to build an alternative set of tools. There's nothing wrong with that, of course. It just suggests that behavioural finance is still very much a work in progress.

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Post by yielder »

ghariton wrote:The best example of what I have in mind is the January effect, which was quite powerful until it was popularized. I understand that it is pretty well indiscernable now.
Ahhh, I see where you're coming from. Anomalies that are short term in nature are likely to disappear because hot, fad chasing money will quickly swamp them. The same thing happened with the Dogs of the Dow. When it stopped working, the money fled. Guess what? The Dogs are working again. And it should because it's a high yield/low PE strategy with some additional implicit parameters inherent in its DJ 30 uninverse. I would expect the January effect to start working again as soon as the hot money can't obtain a +ve return and/or a better fad comes along. Why? The basis for the effect is still in place although I will accept that it exists primarily because of the behavioural short comings of money managers. Will it work as well as before? Probably not because there's probably a residual of hot money that still chases it. Those anomalies that have a short payoff timeframe are likely to disappear and reappear as the hot, instant return money discovers and then abandons them. The longer term payoff anomalies are likely to continue because not enough money has the discipline to buy when they should or the patience to wait if they do buy.
Fair enough. I set myself up for that one. But I think that there are people out there who know more than I do about every conceivable investment opportunity. I don't think I can beat them.
You don't have to know anything about a TD bank beyond what every Canadian knows - there's one on every corner and they've always been there. There were tons of people who know more about TD bank than most of us care to know and huge numbers of them bailed in Q3 and Q4 of 2002. If you'd asked every Canadian, "Will that TD bank on the corner that's always been there, disappear, go out of business?", the answer would have been "No!" It's not a question of what you know but of being able to act on what you know when what you see contradicts what you know. For large cap, blue chip stocks, you don't have to know much about them other than when to identify when they are cheap. That's the easy part although most people think it's the hard part. The hard part which most people don't accept is that you have to be prepared to buy when they are out of favour relative to other investments or have bad news. Then you have to be prepared to hold and re-invest the dividend during your accumulation years despite the itch to "trade". And you diversify.
As an example, on one theory, investors tend to over-react to news (due to the availability heuristic). But they tend to under-react to news. (This is due to over-confidence, combined with anchoring.)
Short term behaviour is very tough to take advantage of because you have to continually & consistently overcome your own irrational/emotional/erratic behaviour. For long term investors, it's a never ending source of amusement and often a buy opportunity.
For an example that is closer to home for me, consider RRBs.


Going back to my TD example, I suspect that the vast majority of people who are aware of RRB's don't know about them they way they know about TD. RRB prices react to real inflation and perceived inflation which is very confusing to investors. If inflation isn't doing anything much, how come my RRB bond fund is dropping in price? (Note that they don't ask if inflation isn't doing anything, how come my RRB bond fund is going up so much in price).

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So with RRBs at about 1.7% currently, is that too high or too low?
I don't know because I can't describe them the way I can a TD - in 30 secs with a crayon to a five year old because the price relationship between real and perceived inflation is very murky.
Instead of a paucity of explanations, it has an over-abundance, with no way of sorting out which ones will be relevant in the future.
Then stay with KISS.
The problem with the rest is that (1) you must believe that the accounting numbers are a fair representation, when we know that it can take months for management and auditors to agree on the wording of a note to the financial statements, so that it obfuscates enough without opeing the auditors up to liability,
This is the Enron Nortel argument. Any of the DJ30 or the S&P aristocrats or the Canadian banks/lifecos/utilities/integrated oils could do a Nortel Notel but the chances are pretty small. To hedge that small chance, diversify.
and (2) trends tend to change unexpectedly -- you never know whether you are riding a parabola or the crest of a sine wave.
Actually, the ones that matter to the long term investor tend to change very slowly and are virtually imperceptible in the short run. Your phrasing suggests to me that you focus on short term results and returns. The market was obviously shocked by TD in Q3 and Q4 of 2002 snd CM in Q3 2005 and there was a lot of selling. Long term investors provided liquidity à la DFA.
Anyway, I note that you seem to use behavioural finance to discredit some of the traditional finance theories (I agree), but not to build an alternative set of tools.
Then let me repeat myself: "Or work from a quality universe such as S&P's Dividend Aristocrats or S&P's A+ (Earnings/Dividend Quality Stocks), ie, piggyback on some fairly strong research and buy 'em when they are relatively cheap. Brandy might like these". You might have missed it because of its kissness.

But don't take my word for it: pictorially with supporting research research. Page 6 of the S&P study shows higher returns and lower or equal variability for the cream. There's also some related research that shows some value in ranking changes.

A final comment - please don't stop what you're doing. Us folks who hide out in the tails beyond the eyes of prying statisticians financial economists don't want to be discovered. :lol: (Or maybe they have poked around and decided not to talk about what they found or maybe they poked around and launched DFA & kept a tight grip on their ivory pedestal ;) ).
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Post by gyrfalcon »

yielder, you're doing a nice job of opening this mantra up. I appreciated the above links.

Here are some thoughts:

Among “Investors”, I suspect there is an inverse relationship between personal experience (i.e. success) at picking specific stocks, and belief in the EMH.

To the extent that “success” reflects true ability, and “failure” reflects inability, both sides can benefit from their beliefs. The believers would presumably choose Index investing while non-believers can continue with personal choices presumably based on deep, and broad, research i.e. due diligence (unless and until proven wrong).

Some of us who are much more aware of human behaviour than we are of formal economic theory, can only be amused that under EMH one assumes that the "typical" investor [stock market participant] is rational, logical, analytical, and makes independent decisions regarding their own buys & sells based on actual information, and *not* simply based on what the stock price itself is doing [ i.e. what others are doing].

What serious observer of the stock market can believe that ?

But as suggested above, a poor theory may benefit many, if not most, investors. It's much more attractive to accept the EMH than it is to accept my IIH [ the Irrational Investor Hypothesis]. gyr.
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Post by yielder »

gyrfalcon wrote:yielder, you're doing a nice job of opening this mantra up. I appreciated the above links.
How understated you are! Fess up. You clapped your hands in glee too when you read it. :lol: :P What behaviourist wouldn't? That would be the rational behaviour. ;)
Among “Investors”, I suspect there is an inverse relationship between personal experience (i.e. success) at picking specific stocks, and belief in the EMH.
A very rational response on their part.
To the extent that “success” reflects true ability, and “failure” reflects inability, both sides can benefit from their beliefs. The believers would presumably choose Index investing while non-believers can continue with personal choices presumably based on deep, and broad, research i.e. due diligence (unless and until proven wrong).
Hmmmmm. I'm a behaviourist who picks stocks successfully by my definition (consistently beat inflation) and also indexes. I don't think that it's a matter of sides but rather a matter of looking at behaviour and modifying it to get the best of all investing worlds: don't chase hot, short term performance but rather buy a wide selection of good, proven companies when they are cheap and hold them (re-investing any dividends (not all will pay dividends but those companies and stocks are a full-blown, separate discussion) during your accumulation years & spending dividends during your consumption years) thus reducing expenses and the tax drag on results. Index where you are over your head (foreign markets ex US, small caps, highly risky sectors such as big pharm). Easy, no? No!
Some of us who are much more aware of human behaviour than we are of formal economic theory, can only be amused
Hmmm. Not too rational to draw conclusions on an incomplete data set. EMH regardless of what it is or isn't is the basis for much of the real economic activity that exists as the NY Times piece points out. Ask most blue chip value investors (as opposed to the falling knife value investors like Irwin Michael) if they would buy an airline and the answer is no. I haven't chewed on it at all but I wonder if there's a connection there to EMH driven airline deregulation. Maybe not because most would buy a US telco from the beginning of dereg although maybe not during the high-priced consolidation phase of the second half of the 90s. Maybe there's a PHD looking to be data mined. :lol:
What serious observer of the stock market can believe that ?
What serious observer of life can believe that?
But as suggested above, a poor theory may benefit many, if not most, investors.


Agreed. But debunking EMH does not mean that people shouldn't index and diversify. That route is still the best solution for most investors. In fact, I'd go so far as to say that behavioural finance makes an even stronger case for diversified indexing than does EMH. FWIW, I think EMH will continue to exist as long as the passwords to CRSP continue to exist. Anecdotally, everytime that a researcher has gone out into the field to find out what is happening he finds results that either haven't been found within the walls of CRSP or contradict results that have been found within the walls of CRSP. Research on The Dividend Puzzle is a good example of the research limitations imposed on the academics by staying within CRSP. Behavioural economists have come up with contradictory and new theories and explanations of market behaviour because their research techniques don't allow them to mine CRSP: they're fishing in a different a different pond, arguably the ocean rather than an interesting little eddy.
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Post by YogiBear »

gyrfalcon wrote:Among “Investors”, I suspect there is an inverse relationship between personal experience (i.e. success) at picking specific stocks, and belief in the EMH.

To the extent that “success” reflects true ability, and “failure” reflects inability, both sides can benefit from their beliefs.
You are making a big assumption when you say that '“success” reflects true ability'- although I note you hedged the statement by a "To the extent that". Based on your formulation, an "investor" that had personal success at stock-picking due entirely to blind luck (how would you know if that is the case or not?) could be expected to not believe in the EMH and thus not index. Is that a tenable long-term position, or is it likely to blow up in their faces at some point?

gyrfalcon wrote:The believers would presumably choose Index investing while non-believers can continue with personal choices presumably based on deep, and broad, research i.e. due diligence (unless and until proven wrong).
Yet again- it's a real shame that the same thing has to be repeated ad nauseam- a belief in the EMH is not a precondition to making a rational choice to index (nor do all believers in EMH decide to index, by any usual definition of "index").

But more interestingly- what happens when and if stock pickers are "proven wrong", i.e., the picks go bad? That would equate to '“failure” [which] reflects inability ["at picking specific stocks"]'- would that mean a sudden conversion to belief in the EMH and a switch to indexing? Of course not- every bit of research into retail stock-picking I've ever heard of repeats the conclusion that there is a lot of self-delusion out there. IOW, there are a lot of retail types who can't stock pick to save their lives, but who forcefully deny any validity to even the weak form of the EMH (witness the interest in TA). These are the sacrificial minnows in the BF pond, not the indexers.
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Post by ghariton »

yielder wrote: I'm a behaviourist who picks stocks successfully by my definition (consistently beat inflation) and also indexes.
Well, if the definition of successful investing is to consistently beat inflation, I have a surefire scheme for you. :wink:
YogiBear wrote:a belief in the EMH is not a precondition to making a rational choice to index
I think that is the heart of the matter.

An alternative reason to index is to believe, as I do, that there is a lot more randomness out there than most people believe. We know from psychology that people seek patterns even when they know there are none. That's just the way humans are hardwired.

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Post by yielder »

ghariton wrote:
yielder wrote: I'm a behaviourist who picks stocks successfully by my definition (consistently beat inflation) and also indexes.
Well, if the definition of successful investing is to consistently beat inflation, I have a surefire scheme for you. :wink:
Well, I toyed with the idea of saying consistently beating inflation by a wide margin. I guess I should have tossed it in to keep the discussion going although we'd have probably gone off on a bit of a tangent.
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Post by gyrfalcon »

YogiBear wrote:
gyrfalcon wrote:Among “Investors”, I suspect there is an inverse relationship between personal experience (i.e. success) at picking specific stocks, and belief in the EMH.

To the extent that “success” reflects true ability, and “failure” reflects inability, both sides can benefit from their beliefs.
You are making a big assumption when you say that '“success” reflects true ability'- although I note you hedged the statement by a "To the extent that". Based on your formulation, an "investor" that had personal success at stock-picking due entirely to blind luck (how would you know if that is the case or not?) could be expected to not believe in the EMH and thus not index. Is that a tenable long-term position, or is it likely to blow up in their faces at some point?

gyrfalcon wrote:The believers would presumably choose Index investing while non-believers can continue with personal choices presumably based on deep, and broad, research i.e. due diligence (unless and until proven wrong).
Yet again- it's a real shame that the same thing has to be repeated ad nauseam- a belief in the EMH is not a precondition to making a rational choice to index (nor do all believers in EMH decide to index, by any usual definition of "index").

But more interestingly- what happens when and if stock pickers are "proven wrong", i.e., the picks go bad? That would equate to '“failure” [which] reflects inability ["at picking specific stocks"]'- would that mean a sudden conversion to belief in the EMH and a switch to indexing? Of course not- every bit of research into retail stock-picking I've ever heard of repeats the conclusion that there is a lot of self-delusion out there. IOW, there are a lot of retail types who can't stock pick to save their lives, but who forcefully deny any validity to even the weak form of the EMH (witness the interest in TA). These are the sacrificial minnows in the BF pond, not the indexers.
You have implied that several concepts were being put forward as hard & fast rules, when they clearly were not. You might want to read it again & put your heart back inside your chest. Or whatever. gyr.
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Post by YogiBear »

gyrfalcon wrote:You have implied that several concepts were being put forward as hard & fast rules, when they clearly were not. You might want to read it again & put your heart back inside your chest. Or whatever. gyr.
Actually, I implied that there was a basis for an interesting discussion on your points- and replied as such. But if you prefer anatomical distractions, heh, that's your choice- have fun ... :roll:
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Post by gyrfalcon »

YogiBear wrote: Actually, I implied that there was a basis for an interesting discussion ...
As you wish. My post was low key with numerous qualifications. Something that comes back with "big assumption", "blow up in their faces", "has to be repeated ad nauseam", and "the sacrificial minnows", just doesn't capture my interest.

[And in case it went by you, the IIH is an obvious joke].

Maybe another time. gyr.
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Post by yielder »

YogiBear wrote: blind luck (how would you know if that is the case or not?) could be expected to not believe in the EMH and thus not index. Is that a tenable long-term position, or is it likely to blow up in their faces at some point?
Up thread, I said "don't chase hot, short term performance but rather buy a wide selection of good, proven companies when they are cheap and hold them (re-investing any dividends (not all will pay dividends but those companies and stocks are a full-blown, separate discussion) during your accumulation years & spending dividends during your consumption years) thus reducing expenses and the tax drag on results".

There's no blind luck in the results not is it likely to blow up in one's face some point.
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Post by YogiBear »

gyrfalcon wrote:[And in case it went by you, the IIH is an obvious joke]
But of course- as is my IPH (Irrational Poster Hypothesis). :wink:
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Post by YogiBear »

yielder wrote:There's no blind luck in the results not is it likely to blow up in one's face some point.
To the extent that you have had "personal success at stock-picking" (I'm not being sarcastic, I just don't know your record except for the statements you make here), then it is entirely possible that they are the result of "true ability" at the sort of security selection that you apparently specialize in, and thus not luck (blind or otherwise). I don't know, but it does not matter either way, because other retail stock-pickers are not you.

It may be obvious to you on the basis of the disciplined application of a solid skill-set when a good, proven company should be bought because it is cheap. To others without your apparent skills and discipline, even "following" the same methodology as you, identification of good companies at a cheap price may be a very random (even accidental) affair, one that might (a la dart throwing) occasionally provide spectacular results, and other times a decent run. These results, however, would have no connection to the application of skill. The short-term success would only serve to promote misplaced confidence in stock-picking ability, until the inevitable "blow up".

The tragedy for these investors flows directly from their initial luck- success is not sustainable. The short-term success only serves to stop them from considering alternative approaches that are better suited to their situation until much more damage than should have been the case occurs. "Better suited" approaches may include indexing- but in some/ many cases could mean low-cost, quality actively managed funds. Or GICs. Whatever truly reflects the balance between skills, emotional game, risk aversion, etc.
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Post by NormR »

Ah Yielder, you're getting sucked into a debate when it is best to continue your search for keen behavioural finance papers. We already get too much of the EMH/indexing mantra around these parts. :)
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Post by yielder »

YogiBear wrote:
To the extent that you have had "personal success at stock-picking" (I'm not being sarcastic, I just don't know your record except for the statements you make here), then it is entirely possible that they are the result of "true ability" at the sort of security selection that you apparently specialize in, and thus not luck (blind or otherwise). I don't know, but it does not matter either way, because other retail stock-pickers are not you.
Don't introduce this into the discussion. It has nothing to do with the statement I made.
skills and discipline
Those are assumed. Obviously without skill and discipline, any results, good or bad, are completely luck.
identification of good companies at a cheap price may be a very random
Did you look at the S&P study that I referenced up thread? First of all, you are working in a universe with parameters that produce better than average results. If you have the ability to identify cheap stocks within this universe and are diversified, then you should be able to improve on those results. Or do you believe that S&P's study is flawed?
The short-term success would only serve to promote misplaced confidence in stock-picking ability, until the inevitable "blow up".
There's no doubt that success leads to confidence. The confidence is not misplaced if one accepts the S&P study as valid and continues to examine it to see whether the additions and deletions to the list provide any useful insight. This kind of digging does provide insight that is extremely useful and can be applied directly to the stock selection process. Blow-up in this case occurs if 1)one stops working with this kind of universe, 2)one is not diversified or 3) one stops buying these stocks when they are cheap.
The tragedy for these investors
ISTM that you are talking in generalities here. Focus on my statement and the specific definition of "good, proven companies" that I have give: those stocks rate A+ or A for dividend and earnings quality by S&P. Many of them overlap, not surprisingly, the S&P Dividend Aristocrats list and Mergents Dividend Achievers list.


PS. I really don't appreciate the use of apparent. Accept or reject; it doesn't matter to me but don't make drive-by comments.
NormR wrote:Ah Yielder, you're getting sucked into a debate when it is best to continue your search for keen behavioural finance papers. We already get too much of the EMH/indexing mantra around these parts. :)
Ah NormR, thanks for you always helpful contributions to the discussion. Glad you liked those keen papers. :lol:
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Post by YogiBear »

yielder wrote:
YogiBear wrote:other retail stock-pickers are not you.
Don't introduce this into the discussion. It has nothing to do with the statement I made.
It has everything to do with the statement I made. The approach you have outlined works for you, and others. It requires, in addition to a certain technical skill-set, in particular mental discipline. It is far from obvious that most retail investors- for all the psychological reasons that have been catalogued at length by many behavioural finance researchers and practitioners- will be able to deploy that mental game in the ways necessary to ensure acceptable results from skill. For most of these people, any success will be in large part the result of luck- not due to any fault with the investing paradigm, but due to the behavioural shortcomings most human investors share, and which make the financial markets the decidedly non-efficient place that they often are. Success due to luck is a poisoned chalice- far better for those investors to find alternate methods to put their money to work, and leave the method you outlined to those capable of making it work.

From reading your replies to my previous post, I cannot decide whether you failed to read what I wrote, or just didn't understand the point I was trying to make:
yielder wrote:
YogiBear wrote:identification of good companies at a cheap price may be a very random
Did you look at the S&P study that I referenced up thread? First of all, you are working in a universe with parameters that produce better than average results. If you have the ability to identify cheap stocks within this universe and are diversified, then you should be able to improve on those results. Or do you believe that S&P's study is flawed?
:?: The study has nothing to do with it. The point I was making (go back and reread it!) is that for those investors who do not "have the ability to identify cheap stocks within this universe", good results using this approach may misleadingly come from "random" choices.

yielder wrote:PS. I really don't appreciate the use of apparent. Accept or reject; it doesn't matter to me but don't make drive-by comments.
I thought (and hoped) that I had made my views clear from the start:
YogiBear wrote:To the extent that you have had "personal success at stock-picking" (I'm not being sarcastic, I just don't know your record except for the statements you make here), then it is entirely possible that they are the result of "true ability" at the sort of security selection that you apparently specialize in, and thus not luck (blind or otherwise). [emphasis added]
You may be comfortable making black and white statements about people that you do not know- I'm not. As I thought would be clear, I was simply referring to your own claims about yourself at face value, without endorsing or judging, as a contrast to those (majority) of investors who are in a different position.

Notwithstanding what NormR (who sees EMH and indexing bogeyman behind every metaphorical tree :wink: ) thinks, I am not a proponent of EMH, except for the weak form (at most- sorry, momentum investors!). I index for other reasons (e.g., cost, regret re manager risk, simplicity), but I also recognize that indexing may not be suitable for many retail investors- just as your methodology, no matter its merits, is not suitable for many. I tried to rely upon behavioural issues to show why. Perhaps my explanations were not well expressed- an old problem of mine, trying to say too much too fast. The re-worded explanation is in this post. I hope it is more clear. That's all. I'm done.
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Post by NormR »

YogiBear wrote:Notwithstanding what NormR (who sees EMH and indexing bogeyman behind every metaphorical tree :wink: ) thinks
:lol:

But here are a few fun links for all involved :)

Confirmation bias / Disconfirmation bias
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Post by yielder »

YogiBear wrote: you, and others.
Much, much different from you.
It requires, in addition to a certain technical skill-set, in particular mental discipline.It is far from obvious that most retail investors- for all the psychological reasons that have been catalogued at length by many behavioural finance researchers and practitioners- will be able to deploy that mental game in the ways necessary to ensure acceptable results from skill.


I'd disagree with you on that one. The kind of stock universe I'm talking about helps to counterbalance much of the psychological hurdles that investors struggle with. Once again you are applying generalities to a specific case. Look at the cheap/expensive discussions that have raged around trusts, around most techs and other growth stocks. It's very easy to determine where cheap and expensive is for a TD type stock. Using PE bands does more or less the same thing. However, INTC and MSFT are a lot tougher to get a grip on because of the relative erratic nature of their earnings. The others tend to have straightish earnings growth over time. It's much easier to buy MMM when it gets hammered 9% in a day as happened on July 7 than it is to buy some high tech with erratic earnings and high expectations high PE. Having that dividend drop into the investor's pocket every quarter and annually getting treated to an increase goes a long way to smoothing butterflies and re-inforcing "correct" behaviour. But you won't kind this kind of info in the research literature because the CRSP oriented financial economists dominate. All you can do is observe recurring anecdotal evidence. Listening to DRIPpers in different forums reveals very similar behavioural responses.
For most of these people, any success will be in large part the result of luck- not due to any fault with the investing paradigm,
Wrong. It is the investing approach that is responsible for the success. It goes a long way to overcome the behaviour that we all exhibit.
and leave the method you outlined to those capable of making it work.
I'd argue that anyone who takes the time to understand the approach, can apply it and make it work.
From reading your replies to my previous post, I cannot decide whether you failed to read what I wrote, or just didn't understand the point I was trying to make:
Do you want to have a discussion or do you just want to be rude? I read what you wrote. I obviously didn't understand. I'll go back and re-read.
:?: The study has nothing to do with it.
The study has everything to do with it. Those who don't have a strong body of evidence to work from are less likely to learn how to identify the cheap stocks & more likely to have difficulty applying what they may have learned. I agree with you that, in this scenario, good results may will misleadingly come from "random" choices, i.e, they'll be damned lucky to have good results for long if at all.
I thought (and hoped) that I had made my views clear from the start:
You most certainly did which frames the question why did you feel that you needed to?
You may be comfortable making black and white statements about people that you do not know- I'm not.


Then you should also be careful about making statements that could be easily misunderstood as you well knew this one could. OK, I've grumbled and vented enough. My apologies.

This conversation was probably guaranteed from the beginning to unfold at cross purposes. You were talking from the generalities of behavioural finance which I agree with while I was talking from the specifics of an approach that neutralizes many of the behavioural shortcomings identified in the BF literature.
Last edited by yielder on 20 Sep 2006 06:18, edited 1 time in total.
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Post by NormR »

yielder wrote:Using PE bands does more or less the same thing.
A supplementary link.

So you have a free/cheap source for such graphs?
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Post by NormR »

Might as well add a few more of Ford's Special Studies
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