Tuesday, April 08, 2008

Tails that wag dogs and other behavioral traps

Friends Jim Ware, CFA and Jamie Zeigler, CFA, co-authors of High Performing Investment Teams: How to Achieve Best Practices of Top Firms, and founders of Focus Consulting Group of Long Grove, IL, say this about their work with investment firms:

"concentrating on understanding and improving behavioral forces at work within the firm and trying to help its financial leaders understand and leverage the firm's culture to achieve a competitive advantage is essential. Avoiding many of the behavioral finance mistakes requires a culture that is self-aware. Managers have to get better at asking themselves, 'What am I doing right now, and why and am I doing it? If I'm selling a stock, what's my real motivation? Are my actions based on a gut feeling or thorough research?'

Michael Ervolini, Founder and CEO of Boston Based Cabot Research, says,

"as an industry, we've talked about behavioral finance for a decade, but until not, portfolio managers have not had a way to apply it. Now's the time to move behavioral finance from cocktail talk to an integrated part of one's investment discipline."

I say take it one step further.

My firm is an SEC registered investment advisor. We've mailed investment performance reports to clients for twenty years.

That’s eighty quarterly reports for the twenty year client, sixty reports for the fifteen year client, and so on and so on.

Before we know it, we've given our otherwise “normal” clients lots and lots of opportunities to draw unintended conclusions from the tail that wags the dog. This, in turn, causes no small numbers of otherwise well-meaning, intelligent people to make unwise financial decisions, for instance, selling out, foregoing further contributions to 401(k) plans, and saving $0.50 by leaving the cream cheese off when ordering a bagel.

I see opportunity.

Besides illustrating your asset allocation or estimating dividends for the coming year, were you truly informed the last time you looked at your broker’s statement? If performance soared or you beat your brother in law, did you feel smart? If seeing the cover of Money Magazine depressed you because they picked the best performing funds, in advance, and you didn't, will this emotional self-whipping help you navigate successfully over the next 50 years or maintain your purchasing power?

I’m passionate about overcoming unproductive behavioral forces, and highly motivated to reengineer this dog-wagging tail of a thing known as investment performance reports.

I'd love to hear ideas, opinions, and feedback.

And heed Jane Bryant Quinn's advice: give financial porn a wide berth.

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