Crashes, Terrorists

,
and Sharks Oh, My!
Why investors fear
the wrong things,
and what to do about it

MIT SLOAN
Investment Conference 2016
Presentation by
Barry Ritholtz,
Chairman & CIO
Ritholtz Wealth Management

Today’s Discussion:

What we fear and why
How distress hurts investment performance
Recognizing and preventing this

How Your Brain Interferes with Your Investing
Behavioral Economics

Neuro-Finance

Risk Aversion

1. Herding, Groupthink

1. Anticipation vs. Rewards

1. Misunderstanding risk

2. Optimism Bias

2. Selective Perception/Retention

2. Why you fear

3. Confirmation Bias

3. Words vs Images

3. Black Swans

4. Expert Opinions

4. Pattern Recognition

4. What will kill you

5. Recency Effect

5. Data vs Narrative

5. Your biggest financial fears

6. Endowment Effect

6. Cognitive Dissonance

6. What hurts performance

7. Hindsight Bias

7. Species of Dopamine Addicts

8. Risk Aversion

A brief introduction to Understanding Risk

Defining Investment Risk

“The probability that actual returns
on an investment will be lower than
the expected returns.”

You Are Going to Die . . . Here’s How.

Shark: A perfectly evolved killing machine, immortalized in Spielberg’s 1975 film, “Jaws.”

6-10 people per year are
killed by sharks worldwide
Other large predators:
Lions (100)
Elephants (100)
Hippos (500)
Crocodiles (1,000)
Dogs (25,000)
Snakes (50,000)

Death by Selfie
1. An American woman fell to
her death while taking a selfie
with her boyfriend on a cliff in
South Africa.
2. Two Russian men were killed
while taking a selfie with a hand
grenade.
3. Three Indian students were
killed by an oncoming train
while taking selfies on train
tracks.
4. A Romanian teenager was
electrocuted when she was
taking a selfie on top of a train
and touched a high-voltage
wire.
5. A Russian teen was also
electrocuted after touching live
wires while taking a selfie near
railway tracks.
6. A Russian woman shot
herself in the head while trying
to take a selfie with a gun.
7. A woman in Moscow City
died falling from a bridge,
where she was trying to take a
selfie.
8. A teenager in Houston,
Texas, fatally shot himself while
taking a selfie with a gun.
9. A Japanese tourist died
falling down the stairs while
taking a selfie at the Taj Mahal.

Source: Ritholtz.com

The Deadliest Animal in the World

Mosquitoes are the deadliest creature
on earth; (Human are only second)
Source: Gates Foundation, CDC

Sentiment Cycle

Source: Ritholtz.com

Investor Performance (10 Years)

Source: DALBAR

Risk of Terrorism

2010: U.S.
noncombatant
fatalities from
terrorism
worldwide = 25
2011: Terror
deaths = 8
Annual deaths
due to struck
by lightning =
29 .

Source: CDC, Mueller & Stewart, Terror, Security, and Money.

What killed Americans in 1900 vs. 2010

Source: LA Times

Your Actual Risk

You are …
35,079 times more likely to die of heart disease
33,842 times more likely to die of cancer
… than a terror attack.
Source: CDC

What are YOU afraid of?

Market Crashes
HyperInflation
Collapse of the
Dollar
Looking foolish…

1987 Crash in Imminent!

Marc Faber: 2014 crash will be worse than 1987’s
CNBC, April 10, 2014

Catastrophizing Markets
Faber on Hyperinflation: “Not A Matter Of If But When” –Business Insider, 9/23/2010
'The Bear Market Is Starting' Marc Faber –CNBC, August 3, 2011
Faber: The Dollar's Value In The Future Will Be Zero –Business Insider, 4/18/ 2011
Marc Faber: We Could Experience A 1987-Style Crash This Year –Business Insider,
5/10/2012
Marc Faber: Look out! A 1987-style crash is coming. –CNBC, August 8, 2013
2014 crash will be worse than 1987's: Marc Faber –CNBC, April 10, 2014
Dr. Doom calls bubble, adding to gloomy calls –CNBC, Nov 2, 2015
My prediction? Sometime in 2016, Faber will predict a 1987-like crash . . .

S&P500 Declines of 20% (or more)

Investor Performance (20 Years)

Catastrophizing Central Bankers
Global Central Banks Are Running ‘Out of Ammo’
(CNN/Money February 9, 2016)
Rate-Hikers At the Fed Are Running Out of Ammo
(CNBC May 13, 2015)
Fed Has No Ammo Left (USA Today March 2014)
Federal Reserve: What Happens When The Fed Really
Does Run Out of Ammo? (Time February 27, 2013)
Fed Running Out of Ammo (Politico July 31, 2012)
Fed Out of Ammo For Economy (WaPo 8/26/ 2011)
Economist, Feb 20th 2016

Fed Running Low on Ammo (WSJ August 26, 2010)
Fed Running Low on Ammo (Reuters August 18, 2009)

Risk Aversion: Pleasure versus Pain

-70%

Jan-26
Jan-28
Jan-30
Jan-32
Jan-34
Jan-36
Jan-38
Jan-40
Jan-42
Jan-44
Jan-46
Jan-48
Jan-50
Jan-52
Jan-54
Jan-56
Jan-58
Jan-60
Jan-62
Jan-64
Jan-66
Jan-68
Jan-70
Jan-72
Jan-74
Jan-76
Jan-78
Jan-80
Jan-82
Jan-84
Jan-86
Jan-88
Jan-90
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Jan-02
Jan-04
Jan-06
Jan-08
Jan-10
Jan-12
Jan-14
Jan-16

Risk . . .

0%

-10%

-20%

-30%

-40%

-50%

-60%

One-Month US Treasury Bills
S&P 500 Index

-80%

-90%

$100,000

Jan-26
Feb-28
Mar-30
Apr-32
May-34
Jun-36
Jul-38
Aug-40
Sep-42
Oct-44
Nov-46
Jan-49
Feb-51
Mar-53
Apr-55
May-57
Jun-59
Jul-61
Aug-63
Sep-65
Oct-67
Nov-69
Jan-72
Feb-74
Mar-76
Apr-78
May-80
Jun-82
Jul-84
Aug-86
Sep-88
Oct-90
Nov-92
Jan-95
Feb-97
Mar-99
Apr-01
May-03
Jun-05
Jul-07
Aug-09
Sep-11
Oct-13
Nov-15

Reward !

$1,000,000

Growth of $100

S&P 500 Index

One-Month US Treasury Bills

$10,000

$1,000

$100

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

Why Investors Lose Money
1. Lack of Discipline
2. Excess Trading
3. High Turnover = High Taxes
4. Unnecessary Trading Costs/Fees
5. Lack of Diversification
6. Over Confidence
7. Deviating from Strategy (“style drift”)
8. Relying on Forecasts or Predictions
9. Listening to Pundits
10. Emotional Decision making

The War Between You & Your Brain

Understand Risk:
a) Recognize its value;
b) Embrace appropriate levels;
c) Beware risk aversion.

Avoid the usual investor errors !

“We have met the
enemy, and he is us.”
-Walt Kelly, Pogo, 1971

for more information, please contact

Barry L. Ritholtz
Chairman,
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