Anyone who has studied a document which illustrates the financial returns of a particular investment is most likely familiar with these words. The regulatory bodies require this disclaimer to be included with any reporting of investment results. While the regulators seek to prevent unscrupulous sales personnel from overpromising results, these words also sum up our next behavioral finance bias. Recency bias has caused many an investor to be disappointed with their selection of a particular security.
One common bias that investors must overcome is known as confirmation bias. It comes into play after we have researched and analyzed a potential investment and made a decision regarding its relative merit. If our impression is that the investment is worthy of purchase and do so, confirmation bias will cause us to only seek out additional information about the investment that confirms our initial positive opinion. Likewise, we will ignore or downplay any new information that contradicts our initial impression. Confirmation bias also works against us when our first research conclusion is negative. If we initially decide not to make a purchase, we will continue to seek out only information that reinforces the original negative assessment.
Behavioral finance researchers have noted that many of our financial decisions are based on “reference points”. Numerous experiments have been conducted which validate the concept that we make decisions based on a previously identified number. For instance, we may have difficulty deciding if $100 is a fair price for an item #1 if we are initially given no other information. However, if we are shown a similar item and told that its price is $200, we become much more likely to state that the $100 item is fairly priced. This belief occurs even though we have received no additional information about item #1. Surprisingly, this is true even when people know the initial item’s $100 price was merely a random amount.
Many people claim to understand that successful investing requires a long-term perspective. Yet, they often lose patience when one of their stock market investments underperforms for a year or two, and they abandon it in search of an alternative. As a self-check on your investing time perspective, ask yourself if you would select the man described below to direct your equity investments.
The Covid-19 pandemic has strained the social safety net as job furloughs and unemployment caused many to lose their regular sources of income. As a result, food banks and other charitable organizations have seen huge increases in the number of people relying on their services. Of course, this increased demand puts financial pressures on the charities, but at least one report suggests that donors stepped up their efforts in this time of need.
The title of this posting may conjure up the image of a beleaguered husband prior to an extensive garage sale, but it is actually a valid question when one looks at the current U.S corporate bond market. “Junk” is an investment term that describes high yield corporate bonds issued by financially challenged corporations. Because of the greater risk of missed interest and principal payments by the issuers of this debt, investors demand higher yields. This, of course, costs the borrowing company more money, so these firms struggle with servicing their debt much more than higher quality “investment grade” bond issuers.
There are no laws of science governing investments but there are some frequently observed, on-going tendencies. One of those tendencies is that over many years, growth investing and value investing tend to converge in terms of financial performance with a slight edge noted for value investing. While definitions of each investing style can vary, growth investing usually refers to selecting the subset of available stocks that seem to be growing sales and profits at a rate that is higher than the market as a whole. Often, these are companies that are relatively young and earlier in their life cycles. Conversely, value stocks tend to be older, more mature companies that have well-established market positions and more predictable dividends and cash flows. Since investors seek increasing profit growth, they bid up the prices of growth stocks with the result being higher readings for accounting valuation measures such as price-to-earnings, price-to-sales and price-to-book value. Conversely, value stocks sport lower ratios for such valuation measures and are sometimes termed “bargain basement stocks.” Each style has extended periods when it outperforms but very long-term performance (20-30 years and up) has tended to converge to somewhat similar results for both styles. Since value stock prices are generally less volatile (a measure of risk), their similar returns accompanied with lower risk causes academicians to give them the edge when comparing the “risk-adjusted” performance of these two investing styles.