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Crashes, Terrorists, Sharks - Oh, My! Why investors fear the wrong things, and what you can
Crashes, Terrorists, Sharks - Oh, My!
Why investors fear the wrong things,
and what you can do about it…
Barry Ritholtz
MAPERs July 2016

This afternoon’s discussion:

I. What do we fear and why?

II. How do our fears impact our performance – as asset managers & fiduciaries?

III. How can we better manage fear?

Part I: What do we fear – & why?
Part I: What do we fear – & why?
Part I: What do we fear – & why?
You Are Going to Die . . . Here’s How.
You Are Going to Die
. . .
Here’s How.
You Are Going to Die . . . Here’s How. Shark : A perfectly evolved killing

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

You Are Going to Die . . . Here’s How. Shark : A perfectly evolved killing
6-10 people per year are killed by sharks worldwide Other large predators: Lions (100) Elephants (100)
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 Fell off a cliff in S. Africa. 2. Live hand grenade (2).
Death by Selfie
1
Fell off a cliff in S. Africa.
2.
Live hand grenade (2).
3.
Oncoming train (3).
4.
Electrocuted
by high-voltage wire (1).
by live wires (1)
6.
Shot in head with a gun.
7.
Fell from bridge.
8.
Fatally shot himself
9.
Fell down Taj Mahal steps
Source: Ritholtz.com
The Deadliest Animal in the World Mosquitoes are the deadliest creature on earth; (Human are only
The Deadliest Animal in the World
Mosquitoes are the deadliest creature on earth;
(Human are only second)
Source: Gates Foundation, CDC
What killed Americans in 1900 vs. 2010
What killed Americans in 1900 vs. 2010
What killed Americans in 1900 vs. 2010 Source: LA Times

Source: LA Times

What killed Americans in 1900 vs. 2010 Source: LA Times
Risk of Terrorism? 2010: U.S. noncombatant fatalities from terrorism worldwide = 25 2011: Terror deaths =
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.

Risk of Terrorism? 2010: U.S. noncombatant fatalities from terrorism worldwide = 25 2011: Terror deaths =
Your Actual Risk
Your Actual Risk

You are … 35,079 times more likely to die of heart disease 33,842 times more likely to die of cancer

Source: CDC

… than a terror attack.

Your Actual Risk You are … 35,079 times more likely to die of heart disease 33,842
Fear of Flying ? Fear = emotional decision- making = bad judgment = bad outcomes Max
Fear of Flying ?
Fear =
emotional decision-
making =
bad judgment =
bad outcomes
Max Planck Institute (Berlin)
Fear of Flying ? Fear = emotional decision- making = bad judgment = bad outcomes Max
Crash! Hyperinflation! Dollar Collapse! Market Crashes HyperInflation Collapse of the Dollar Looking foolish…
Crash! Hyperinflation! Dollar Collapse!
Market Crashes
HyperInflation
Collapse of the
Dollar
Looking foolish…
What are we afraid of in Markets?
What are we afraid of in Markets?
What are we afraid of in Markets?
S&P500 Declines of 20% (or more)
S&P500 Declines of 20% (or more)
Catastrophizing Markets
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”

5/10/2012

–Business Insider,

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

“Asset Markets Will Crash Like Titanic” -Bloomberg, January 6, 2016

Repeatedly Forecasting the Next Crash
Repeatedly Forecasting the Next Crash
Catastrophizing Central Bankers
Catastrophizing Central Bankers
Catastrophizing Central Bankers Economist, Feb 20th 2016 Global Central Banks Are Running ‘Out of Ammo’ (CNN/Money

Economist, Feb 20th 2016

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)

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

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

Part II: How do our fears impact our performance?
Part II: How do our fears impact our performance?

How Your Brain Interferes with Your Investing

Behavioral Economics

1. Herding, Groupthink

  • 2. Optimism Bias

  • 3. Confirmation Bias

  • 4. Expert Opinions

  • 5. Recency Effect

  • 6. Endowment Effect

  • 7. Hindsight Bias

Neuro-Finance

1. Anticipation vs. Rewards

  • 2. Selective Perception/Retention

  • 3. Words vs Images

  • 4. Pattern Recognition

  • 5. Data vs Narrative

  • 6. Cognitive Dissonance

  • 7. Species of Dopamine Addicts

Risk Aversion

1. Misunderstanding risk

  • 2. The purpose of fear

  • 3. Black Swans

  • 4. Evolutionary baggage

  • 5. Biggest Financial Fears

  • 6. Overcompensation

  • 7. What hurts performance

Off Label Use

Off Label Use antihistamine diphenhydramine.

sildeenafil

Off Label Use antihistamine diphenhydramine.

antihistamine diphenhydramine.

Your Brain
Your Brain
Your Brain on Stocks (“Off Label”)
Your Brain on Stocks (“Off Label”)
Risk Aversion: Pleasure versus Pain
Risk Aversion: Pleasure versus Pain
EarthQuake Insurance
EarthQuake Insurance
Investor Performance (10 Years)
Investor Performance (10 Years)

Source: DALBAR

Investor Performance (20 Years)
Investor Performance (20 Years)
Sentiment Cycle Source: Ritholtz.com
Sentiment Cycle
Source: Ritholtz.com
2003: Politics and Asset Management Don’t Mix
2003: Politics and Asset Management Don’t Mix

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

Source: Ritholtz.com BigCharts.com
Source: Ritholtz.com BigCharts.com
2003: Politics and Asset Management Don’t Mix
2003: Politics and Asset Management Don’t Mix

2003 Tax Cuts > $1 Trillion Up over 90% over 4 years

Source: Ritholtz.com, BigCharts.com
Source: Ritholtz.com, BigCharts.com
2009: Political Investing
2009: Political Investing

Obama is a Socialist! Stay Out of Markets!

2009: Political Investing Obama is a Socialist! Stay Out of Markets! Source: Ritholtz.com, BigCharts.com
Source: Ritholtz.com, BigCharts.com
Source: Ritholtz.com, BigCharts.com
2009: Politics and Asset Management Don’t Mix
2009: Politics and Asset Management Don’t Mix

FASB 157, ZIRP, QE +VERY Oversold Markets Up 250% over 76 months

Source: Ritholtz.com, BigCharts.com
Source: Ritholtz.com, BigCharts.com
Part III: Managing our fears through data
Part III: Managing our fears through data
Part III: Managing our fears through data
Defining Investment Risk
Defining Investment Risk

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

Defining Investment Risk “The probability that actual returns on an investment will be lower than the
Fear of Deadly Viruses
Fear of Deadly Viruses
Fear of Deadly Viruses
Crime Wave!
Crime Wave!
Crime Wave!
Crime: The Trend is Your Friend !
Crime: The Trend is Your Friend !
Crime: The Trend is Your Friend !
Risk . . . 0% -10% -20% -30% -40% -50% -60% -70% One-Month US Treasury Bills
Risk
. .
.
0%
-10%
-20%
-30%
-40%
-50%
-60%
-70%
One-Month US Treasury Bills
S&P 500 Index
-80%
-90%
Jan-26
Feb-28
Mar-30
Apr-32
May-34
Jun-36
Jul-38
Aug-40
Sep-42
Oct-44
Nov-46
Dec-48
Jan-51
Feb-53
Mar-55
Apr-57
May-59
Jun-61
Jul-63
Aug-65
Sep-67
Oct-69
Nov-71
Dec-73
Jan-76
Feb-78
Mar-80
Apr-82
May-84
Jun-86
Jul-88
Aug-90
Sep-92
Oct-94
Nov-96
Dec-98
Jan-01
Feb-03
Mar-05
Apr-07
May-09
Jun-11
Jul-13
Aug-15
Reward !
Reward !
$1,000,000 Growth of $100 $100,000 S&P 500 Index One-Month US Treasury Bills $10,000 $1,000 $100 Jan-26
$1,000,000
Growth of $100
$100,000
S&P 500 Index
One-Month US Treasury Bills
$10,000
$1,000
$100
Jan-26
Mar-28
May-30
Jul-32
Sep-34
Nov-36
Jan-39
Mar-41
May-43
Jul-45
Sep-47
Nov-49
Jan-52
Mar-54
May-56
Jul-58
Sep-60
Nov-62
Jan-65
Mar-67
May-69
Jul-71
Sep-73
Nov-75
Jan-78
Mar-80
May-82
Jul-84
Sep-86
Nov-88
Jan-91
Mar-93
May-95
Jul-97
Sep-99
Nov-01
Jan-04
Mar-06
May-08
Jul-10
Sep-12
Nov-14
Markets Have Rewarded Discipline
Markets Have Rewarded Discipline

MSCI World Index,1970–2013

BusinessWeek: Dotcom Eurozone “The Death Dow drops 23% on stock debt crisis of Equities” BusinessWeek: Black
BusinessWeek:
Dotcom
Eurozone
“The Death
Dow drops 23% on
stock
debt crisis
of Equities”
BusinessWeek:
Black Monday
Dow drops
Incom
Dotcom
crash
Euro zone
Income tax
“The Death of
23% on Black
e tax
stock
debt
rates rise
S&P 500
Equities”
Monday
rates
crash
9/11
crisis
Arab oil
down 46%
Y2K
rate
terrorist
S&P 500
embargo
Y2K
9/11
Scare
attacks
down 46%
Arab oil
Scar
terrorist
$43
embargo
Savings
e
attack
Gold hits
Gold hits
Savings and
Oil prices
and loan
US home
record high
record high
Hurricanes
Oil prices
loan crisis
quadruple
crisis
Hurricanes
US home
prices hit
Katrina
quadruple
Russian
Russian
Katrina
prices
bottom
and Rita
US
financial
financial
and Rita
hit
US inflation
inflation
crisis
Iraq
bottom
S&P 500
S&P 500
at 13.5%
crisis
Fiscal
at
Iraq
Iraq war Subprime Subprime
war
down 43%
down
Iraq
1
Asian
cliff
13.5%
Asian
begins
mortgage
invades
mortgage
begin
Fiscal
currency
43%
invades
worries
currency
crisis
Kuwait
crisis
s
cliff
Kuwait
crisis
crisis
worries
1970
1980
1990
2000
2010 2013
1970
1980 1990
2000
2010
2013
A disciplined investor looks beyond the
concerns of today to the long-term growth
potential of markets.
In US dollars. Indices are not available for direct investment. Their performance does not reflect the
In US dollars. Indices are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is no
guarantee of future results. MSCI data © MSCI 2014, all rights reserved.
39
You Don’t Have to Pick Just One 200% "The Lost Decade" Total Returns January 2000 -
You Don’t Have to Pick Just One
200%
"The Lost Decade" Total Returns January 2000 - December 2009
176%
154%
150%
121%
110%
100%
92%
85%
82%
50%
41%
28%
12%
0%
-9%
-50%
40
40
Complex vs. Simple
Complex vs. Simple

The Endowment Model

Asset Allocation

Opaque: Illiquid Securities, Leverage & Little Transparency

Transparent: Liquid Holdings, Daily Pricing & Complete Transparency

Operationally Challenging with Higher Fees

Operationally Ecient with Lower Fees

Risk measurement through complex quantitative risk models

Risk management through intelligent asset allocation & diversification

Try to avoid volatility

Use volatility to your advantage and survive periods of severe disruptions

Complex vs. Simple The Endowment Model Asset Allocation Opaque: Illiquid Securities, Leverage & Little Transparency Transparent:
The Diversified Portfolio
The Diversified Portfolio

Portfolio Yield: 2.77% Annual Expense Ratio: 0.29%

The Diversified Portfolio Portfolio Yield: 2.77% Annual Expense Ratio: 0.29% Asset Class International Stocks U.S. Large

Asset Class

International Stocks U.S. Large Cap Stocks U.S. Investment Grade Bonds Emerging Market Stocks U.S. Mid Cap Stocks U.S. Small Cap Stocks Mortgage Backed Bonds Inflation Protected Treasury Bonds Real Estate Investment Trusts U.S. High-Yield Bonds Cash

Allocation

24%

18%

14%

9%

8%

7%

6%

5%

4%

4%

1% 42
1%
42
Why Institutional Investors Underperform *
Why Institutional Investors Underperform *

1. High Fees Reduce Returns

  • 2. Lack of Discipline

  • 3. Excessive Trading / Costs

  • 4. Incoherent Investment Philosophy

  • 5. High Turnover

  • 6. Over Confidence

  • 7. Deviating from Strategy (“style drift”)

  • 8. Believing Forecasts / Predictions

  • 9. Over-Concentration of Holdings

10. Emotional Decision-making

Organizational Alpha
Organizational Alpha

1. Size/Ability to Negotiate Fees

  • 2. Infinite time horizon

  • 3. Behavior (Crisis Alpha)

  • 4. Investment Philosophy

  • 5. Organizational Structure

  • 6. Process

  • 7. Quality Control

  • 8. Setting Reasonable Expectations

  • 9. Communications

10. Unemotional decision-making

What You Can Control
What You Can Control
The War Between You & Your Brain
The War Between You & Your Brain

Understand Risk:

  • a) Recognize its importance to

achieving returns; b) Embrace appropriate levels;

  • c) Beware risk aversion.

The War Between You & Your Brain Understand Risk: a) Recognize its importance to achieving returns;

Avoid the usual mistakes!

We have met the enemy, and he is us.

-Walt Kelly, Pogo, 1971

“ 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
for more information, please contact
Barry L. Ritholtz
Chairman & Chief Investment Officer,
Ritholtz Wealth Management
90 Park Avenue, 18 th 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/behavioral-books