Presentation by

Barry Ritholtz
November 8, 2017

Politics & Investing Dont Mix

Why You Are Not Wired to Make

Intelligent Financial Decisions
 Todays Discussion:

1. Understand the way humans have evolved, and what that

means for our decision-making

2. Review Investor Behavior, focusing on relationship

between politics and markets

3. Learn how you can help prevent yourself from making these
self-inflicted investing errors
A brief intro to
Behavioral
Economics &
NeuroFinance
 How Your Brain Interferes with Your Investing

Behavioral Economics Neuro-Finance Risk Aversion

1. Anticipation vs. Rewards 1. Humans dont understand risk

1. Herding, Groupthink
2. Selective Perception/Retention 2. What we fear
2. Optimism Bias
3. Words vs Images 3. Black Swans
3. Confirmation Bias
4. Pattern Recognition 4. What will kill you
4. Expert Opinions
5. Data vs Narrative 5. Clients biggest financial Fears
5. Recency Effect
6. Cognitive Dissonance 5. What hurts their portfolios
6. Endowment Effect
7. Hindsight Bias 7. Species of Dopamine Addicts
 This
is
your
brain

Your brain weighs 3 pounds, and is 100,000 years old. It is a dynamic, opportunistic, self-organizing system
of systems. MRIs have revealed to Neurologists what our brains looks like when making decisions. We can
observe it 1) in real time; 2) under actual conditions, and 3) in reaction to financial risk/reward stimuli.

Once we begin trading stocks, however, our brains begin to undergo subtle physical change that we can
actually see in the MRIs of Traders . . .
 This
is
your
brain
on
stocks
Lake Wobegone Effect
 Dunning Kruger Effect
Dunning Kruger Effect: DK is a cognitive bias in which unskilled people make poor
decisions and reach erroneous conclusions, but their incompetence denies them the
metacognitive ability to recognize these mistakes.

Metacognition: The less competent you are at a task, the more likely you are to over-
estimate your ability to accomplish it well. Competence in a given field actually weakens
self-confidence.

This has devastating consequences in the investment world.

University of Mannheim surveyed investors, asking

them about performance. Most considered themselves
above average. On average, investors overestimated
annual returns by 11.6% per year. In fact, the lower
the actual returns the worse they were at judging their
returns.

The correlation between self ratings and actual

performance is not distinguishable from zero.
 The Sideways Effect
In 2004, Merlot was the best
selling wine in America = 15%
of all sales.

Pinot Noir was < 3%

Paul Giamatti (Miles): I am

NOT drinking any f&%king
Merlot!

Merlot sales plummeted 35%

and Pinot Noir sales rose more
than a 100%.

This became known as the

Sideways Effect.
Sources: IMDB, Wines & Vines
This animation . . .

. . . is not an animation
If u cn rd ths
 When it absolutely positively
has to deceive your eyes overnight

Source: Federal Express

 No, this was not photoshopped

Source: 11even.net
 Herding

Mutual of Omaha

Lone Gazelle

Source: Kal, Economist

 Optimism Bias

Here, Kitty, Kitty, Kitty

 Analysts: Over-Optimistic GroupThink

Analysts have been persistently overoptimistic for the

past 25 years, with [earnings] estimates ranging from 10 to
12 percent a year, compared with actual earnings growth of
6 percent On average, analysts forecasts have been
almost 100 percent too high

-McKinsey study

Source: McKinsey & Co.

 Expert Forecasting versus Ambiguous Uncertainty
Expert forecasters do no better than the average member
of the public; Statistically, expert predictions are the =
random guesses. (Philip Tetlock)

Experts acknowledge future is inherently unknowable are

perceived as being uncertain and therefore less
trustworthy. (Isaiah Berlin: Hedgehog vs Fox)

The more self-confident an expert appears, the worse

their track record is likely to be. And, the more likely he is
to be believed by TV viewers;

Most famous = least accurate.

Least accurate = most confident

Forecasters who get a single big outlier correct are more

likely to underperform the rest of the time;

The Articulate incompetents The Tao Jones (1984) by

Bennett Goodspeed

Source: Zweig, Your Money & Your Brain; Grants Interest Rate Observer,
 Confirmation Bias
Selective Perception & Retention
1. We tend to read that which we
agree with; We avoid that which
disagrees with our preconceived
biases, notions or ideologies;

2. Our biases change the way we

perceive objects literally, the way
we see the world.

3. The same biases affect our

memories we retain less of what
we disagree with . . .

4. Expectations Affect Perception

 What Just Happened vs. What is Going to Happen
Time, June 2005 Fortune, June 2005

Source: Fortune, Time

 Beware the Recency Effect
WSJ: 2007 WSJ: 2010

Source: WSJ
Part II: Politics and Markets
 2003: Politics and Asset Management Dont Mix

These are poorly designed tax cuts - Stay Out of Markets!

Source: Ritholtz.com BigCharts.com

 2003: Politics and Asset Management Dont Mix
2003 Tax Cuts > $1 Trillion

How did that political trade up over 90% over 4 years

work out for you . . . ?

Source: Ritholtz.com, BigCharts.com

 2009: Political Investing

Obama is a Socialist! Stay Out of Markets!

Source: Ritholtz.com, BigCharts.com

 2009: Politics and Asset Management Dont Mix
FASB 157, ZIRP, QE +VERY Oversold Markets
The political trader missed the best rally in a generation
Up 3X over 8 years

Source: Ritholtz.com, BigCharts.com

 Clinton State of the Union Address, 2000

We begin the new century with over 20 million new jobs; the fastest economic
growth in more than 30 years; the lowest unemployment rates in 30 years; the lowest
poverty rates in 20 years; the lowest African-American and Hispanic unemployment
rates on record; the first back-to-back budget surpluses in 42 years. And next month,
America will achieve the longest period of economic growth in our entire history.

We have built a new economy. And our economic revolution has been matched by a
revival of the American spirit: crime down by 20%, to its lowest level in 25 years; teen
births down seven years in a row; adoptions up by 30%; welfare rolls cut in half to
their lowest levels in 30 years.

My fellow Americans, the state of our union is the strongest it has ever been.

[Soon after, markets collapsed and the economy suffered its worst decade in 80 years]

Source: Morgan Housel, Motley Fool

 Obama State of the Union address, 2010

One in 10 Americans still cannot find work. Many businesses have shuttered. Home
values have declined. Small towns and rural communities have been hit especially
hard.

And for those who'd already known poverty, life has become that much harder. This
recession has also compounded the burdens that America's families have been dealing
with for decades -- the burden of working harder and longer for less; of being unable to
save enough to retire or help kids with college.

[Soon after, stocks surged.]

Source: Morgan Housel, Motley Fool

 What Does North Korea Mean for Your Portfolio?

1
 Possible Outcomes of Nuclear Conflict

2
Part III: Managing our bad behavior
 Sentiment Cycle

Source: Ritholtz.com
Repeatedly Forecasting the Next Crash
What Makes the Market Tick?
 Investor Performance (10 Years)

Source: DALBAR
Investor Performance (20 Years)
Fear of Deadly Viruses
Crime: The Trend is Your Friend !
 Now I understand these
cognitive issues, what can I
do about them?

Avoid making all the usual errors

investors make!
 We have met the
enemy, and he is us.

-Walt Kelly, Pogo, 1971

 for more information, please contact

Barry L. Ritholtz

Chief Investment Officer,

Ritholtz Wealth Management
90 Park Avenue, 18th floor
New York, NY 10016
212-455-9122
Info@RitholtzWealth.com

My favorite books on these subjects can be found at

http://www.ritholtz.com/blog/behavioral-books