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Tuesday, July 31, 2012

Anchoring and Decision Making


The cognitive bias that describes our common tendency to place too much emphasis on one trait or piece of information when making a decision is called anchoring. This occurs during the normal decision making process when we rely too heavily on a specific piece of information which governs our thought process.
Once the anchor is stamped in our mind there is a bias set towards adjusting all information to reflect the anchored information. This cognitive bias is often developed at a young age when it is reinforced through our learning process.
Anchoring has a strong impact on our beliefs about money. The financial decision making process an individual moves through is reflective of their perception of money. For example, a person looks at investing in a company they may focus excessively on a certain element of fundamental analysis and use those criteria as a basis for evaluating the value of the investment, rather than considering all the proper elements of complete due diligence. The bias will cause the investor to view all future information in a manner that reinforces their decision.
These decision traps commonly lead to investors staying too long with an investment as well as developing a very large blind spot with regards to the initial investment decision.
Understanding the psychology of your decision making process will allow you to eliminate pre-conditioned bias’ which reduce your probability of making successful financial decisions. Awareness will also help you develop an objective decision making process.
Scam and fraud victims are manipulated through the knowledge and experience their perpetrators have in the field of psychology. In order to insulate and inoculate yourself fully you must understand the psychology behind your financial decision making process. You don’t stand a chance if you haven’t gained full awareness of your anchors. Believe me when I tell you that the professional scammers and fraudsters will find your anchors very quickly and devise a strategy to use to their best interests.
Your focus points for this concept are simple; return to your journal and review your last 5 investment decisions. Take the time to reflect on the answers to several questions:
1.      What is the most important aspect of an investment for me?

2.      What is my due diligence process?

3.      What must an investment not have that makes me decide to say no?

4.      What must an investment have for me to say yes?

5.      Why do I want to invest?

Wednesday, July 25, 2012

Perception of Value

An important psychological factor that influences our investment decision making process is the concept of perceived value. Predatory sales people have long manipulated this concept to sell their products.

Value much like beauty is in the eye of the beholder. If I can make you see value I can get you to make the decision I want you to make. The secret is in the creation of perceived value. This can be directly connected to loss aversion through the concept of sunk costs.

Once you make a decision to invest or spend your hard earned money you have committed to a perceived value in your mind. This value has to continue to be as you perceived it or it causes great psychic pain. You can't allow the pain of poor decision to interfere with you perception of value.Unfortunately the vast majority fo the time someone else has dictated the value for you. This commonly happens because very few people are consciously aware of what they truly value.

Rational behavior would suggest that an individual would make on-going decsions based upon their own best interests, they wouldn't allow perception to interfere. Yet we consistently allow our best interests to be ignored in order to protect the value of previous decisions. This allows us to protect our self-image when we have erred substantially. This is one of the most common reasons individuals are easily manipulated by scammers and fraudsters.

Victims of scams and frauds will work overtime to protect their self-image and deny all existence of evidence which was available prior to their poor financial decision. After all in order to face this pain we would have to admit and feel the pain associated to our own guilt associated with our greed.

No one wants to admit they fell victim to their own greed. We will do anything to avoid this reality.

This is the reason we hold on to investments to long even when all hope of gain is lost. It is also the reason we will make even poorer decisions attempting to regain what we lost. This never ending cycle ends just as it does for the degenerent gambler. The difference is that the gambler can lean on the premise that they have an illness. The same psychological triggers are in play for the investor who becomes victimized by the scammers and fraudsters.

In general you can insulate and inoculate yourself from these events by identifying your own personal values. Once you have a keen understanding of your sense of value you can begin to make better decisions in financial matters. Your journal comes into play once again, write down the following question and make the effort to go at least 7 levels deep with it. What's important about money to me? Write down your answer and then re-ask the question for another level. Continue for at least 7 levels and you will identify the most important values for your invesment making decisions. Once you have this foundation it will be increasingly difficult for anyone to manipulate your perception of what value is for you.

Tuesday, July 17, 2012

Psychology of Investing: Self-Sabotage


This is also known as self-handicapping. We all have the propensity to create self-limiting obstacles. This allows us to fail without feeling any great remorse or guilt. By setting a limitation that gives us an excuse we protect ourselves from full accountability.

It is always less painful to say I wasn’t at my best today, or I had this particular handicap which was directly causative for this perceived failure.

Think back, have you ever said you’re not feeling to well before an important presentation but you were going to suck it up and make the presentation anyway? Of course the self-fulfilling prophesy is that you didn’t make the sale. Or maybe you suddenly had some back pain prior to stepping out on the golf course for that minor tournament opportunity. These are examples of self-handicapping, basically it your sub-conscious effort to create a convenient excuse for lack of success. It is a protection behavior trait.

For the investor this behavior is the corollary to over-confidence. Most damaging however, this is a psychological trigger to move directly towards what we are attempting to avoid which is failure or a poor result.  The creation of the comfortable excuse protects us from experiencing the pain of a poor result. It allows us to avoid accountability and clears us from the potential guilt that accompanies a poor result.

Unfortunately the protective mechanism simply reinforces and assures the poor result. We have created a self-fulfilling prophesy and have no chance for success.

By recognizing this psychological trigger or behavior trait we can make the necessary adjustment needed to control the decision making process. Once freed of the need to avoid pain we can comfortably complete the due diligence and work through a proper decision making process. Only then can we clearly make good decisions about money. It also allows us to make proper adjustments when we get poor results.
www.karlschilling.net

Monday, July 16, 2012

Psychology of Investing: Loss Aversion


“Oh the tangled web we weave when first we practice to deceive” Sir Walter Scott eloquently penned the tragedy of deception. The most telling deception though is self-deception. We suffer with this tragedy on a daily basis.

No more telling aspect of self-deception than that of loss aversion. Basic human nature holds that we move towards pleasure and away from pain, yet in this avoidance we feel and remember the pain more consistently than the pleasure. One of the basic laws of psychology is simply that we get more of that which we focus on then that which we do not. The most telling thoughts in one’s mind manifest the reality of experiences for that individual. Therefore it follows that when we spend psychic energy in the practice of avoidance we get more that which we seek to avoid.

A simple example of this is laying golf, for you duffers reading this I’m sure you have experienced the dreaded “don’t hit it in the water” trap. The message that the mind is focused on is hit it in the water not, as the sub-conscious mind does not differentiate between good and bad, negative and positive. So when you focus on what do don’t want to happen, you end receiving the very thing you were avoiding and presto the ball is in the water.

So it is with the concept of loss aversion. The investment psychology for many is to obsess upon the poor stocks and ignore the totally successful aspects in the portfolio. We are perfectly willing to sell and take some profits, but bitterly opposed to selling off losers. This also leads to the most dreaded of all behavior the buy high sell low syndrome. Loss aversion is the basic foundation to this process of consistently buying high and selling low.

Regret plays a role in our loss aversion mentality. It is regret that leads us to non-distinguish between a poor decision and a poor outcome. By falling into regret over a poor outcome we tend to overlook the good investment decision on a company and suffer during a weak performance which many times lead to selling off low as opposed to increasing a position at the bottom of a good investment.

As previously discussed we tend to feel pain more than pleasure and this combined with regret tends to lead us down the path of staying too long when we refuse to move on the early pain.

Recognizing these behaviors is the first step in proactively taking control of our thoughts and processing information in a new and improved style.

Friday, July 13, 2012

Selective Memory


The dangers of overconfidence lead to a vicious cycle of continued negative behaviors that greatly impact investing success. One of the bi-products of overconfidence is selective memory. Very few of us like to remember painful experiences especially past failures. The inability to use failure positively contributes to a distinct avoidance of failure.

This avoidance directly advances selective memory. We chose to remember only the positive aspects of our past decisions which reinforce our positive self-image. We tend to avoid any realities of the pain caused by loss or poor decisions about money. This create a vicious cycle and puts us much like a hamster on a wheel going round and round using the identical flawed decision making process which caused our original pain.
Selective memory becomes a key reason why victims of scams have a multiple history of being scammed. Yes there are other major factors in becoming a serial victim but selective memory is a core element in this process.
This selective memory process is a form of correcting for cognitive dissonance which is a well-accepted theory in Psychology. This theory suggests that holding two apparently disparate ideas, opinions, attitudes, beliefs or behaviors at the same time and therefore our psyche will need to find a correction for this.

Over time we will correct to ensure that the memories are congruent with our self-image belief. We need to adjust the reality to conform to our own comfortable self-image.
We also are guilty of pacing too much weight on the recent short-term evidence while making decisions and ignoring long term evidence that adds weight to our risk analysis.
The best way to overcome this negative behavior trait is to journal your decision making process when making an investment. This will leave a permanent record of your attitudes, beliefs and values at the time of the investment. This record will allow you to determine the true value of the investment decision and whether your decision making process was sound at this time.
Next time we will discuss the concept of Loss Aversion
www.karlschilling.net

Wednesday, July 11, 2012

Investing Behaviors


The theory of Behavioral Finance has grown during the last 20 years or so. A study of this field will yield much functional information on the psychology of investing. As an investor you will be effectively prepared for success if you can identify the poor behaviors that lead to loss. As you are aware my work has been focused on helping investors and consumers avoid being victimized by scams, frauds and predatory sales tactics. The majority of this work is focused on the individual and the behavior traits that lead to victimization.

Most services or professional advisors seek to identify the scams and frauds in order to protect the potential victims; this unfortunately is much like prescribing aspirin for cancer. The reality is that victims subject themselves to the scam, fraud or predatory sales tactic. Even identifying the scams and frauds wouldn’t be a fulfilling solution to insulating victims. The only pure cure is helping the potential victim understand the psychological triggers that initiate the launch codes for the perpetrators of the scams and frauds.

Once you understand the behavioral traits that commonly create victimization you will be able to fully inoculate and insulate yourself from scams, frauds and predatory sales tactics. With this information and education you will be successfully identify all scams, frauds and predatory sales tactics with minimal effort.

Today let’s review a common psychological trait that hampers investors from consistent success. Overconfidence is the commonality for human beings to think we are smarter and more sophisticated then we actually are. Studies have proven that when people say they are 90% sure of something they are right only 70% of the time. You can remember a time when you were absolutely certain about something and then totally amazed that you were incorrect, remember? This overconfidence for investors’ shows up in the behavior of rapid trading due to the thought that we are smarter than the person on the other side of the trade.  Rapid trading leads to unrecognized losses in the form of commissions, fees and taxes. In the end the annual returns are negative as the losses add up. The need for control is the behavior trait behind the overconfidence. If we are more active in our investments then we have stronger control and feel a sense of comfort that comes with full control. Unfortunately our inability to recognize the overconfident behavior leads us to losses.

Tomorrow we will look at the psychological trait of selective memory and how that impacts our investing behaviors.

Saturday, July 7, 2012

Adverse selection and the Obamacare Death Spiral


The death spiral built into Obamacare is the concept of adverse selection. It seems the law makers who jumped on board with President Obama overlooked a small inconvenience in their misunderstanding of this concept. Let’s take a look at adverse selection and how it impacts insurance providers:

The term adverse selection was originally used in insurance. It describes a situation where an individual's demand for insurance (either the propensity to buy insurance, or the quantity purchased, or both) is positively correlated with the individual's risk of loss (e.g. higher risks buy more insurance), and the insurer is unable to allow for this correlation in the price of insurance.[This may be because of private information known only to the individual (information asymmetry), or because of regulations or social norms which prevent the insurer from using certain categories of known information to set prices (e.g. the insurer may be prohibited from using information such as gender, ethnic origin, genetic test results, or preexisting medical conditions, the last of which amount to a 100% risk of the losses associated with the treatment of that condition). The latter scenario is sometimes referred to as 'regulatory adverse selection'

Furthermore, if there is a range of increasing risk categories in the population, the increase in the insurance price due to adverse selection may lead the lowest remaining risks to cancel or not renew their insurance. This leads to a further increase in price, and hence the lowest remaining risks cancel their insurance, leading to a further increase in price, and so on. Eventually this 'adverse selection spiral' might in theory lead to the collapse of the insurance market.

To counter the effects of adverse selection, insurers (to the extent that laws permit) ask a range of questions and may request medical or other reports on individuals who apply to buy insurance, so that the price quoted can be varied accordingly, and any unreasonably high or unpredictable risks rejected. This risk selection process is known as underwriting. In many countries, insurance law incorporates an 'utmost good faith' or uberrima fides doctrine which requires potential customers to answer any underwriting questions asked by the insurer fully and honestly; if they fail to do this, the insurer may later refuse to pay claims.

One reason why adverse selection may be muted in practice may be that insurers' underwriting is largely effective. Another possible reason is negative correlation between risk aversion (e.g., the willingness to purchase insurance) and risk level (estimated ex ante based on observation of the ex post occurrence rate of observed claims) in the population: If risk aversion is higher amongst lower risk customers, such that persons less likely to engage in risk-increasing behavior are more likely to engage in risk-decreasing behavior (i.e., to take affirmative steps to reduce risk), adverse selection can be reduced or even reversed, leading to 'propitious' or 'advantageous' selection

The mandate to purchase insurance will not offset the disadvantages to insurers of being forced to take on ALL pre-existing conditions. The pool of so called uninsurable will not be offset by the so-called reasonable risks who will have to pay exorbitantly higher premiums for their own coverage. This has never worked and the new law is simply mandating that insurers discontinue underwriting. Without underwriting there is no way to level premiums or factor future claims costs. It simply will lead to bankrupting the majority of health insurers. The WH contention that there will somehow be “affordable” insurance laughs considerably in the face of reason.

The reality is for any health insurance coverages to be enforced the premiums will have to become prohibitive. (I personally just received a 24% increase on my renewal from BC/BS, and I was claims free for the entire year and also have no adverse health history to speak of). These prohibitive premiums will be the direct correlation for healthy individuals to choose the penalty (not a tax according to Obama, only a tax according to SCOTUS) instead of the insurance premium. President Obama likes to say that Americans will be responsible and pay for insurance instead of the lower costs of the penalty. Yet the reality will rapidly become that healthy individuals will not want to pay exorbitant premiums for the adverse selection that is mandated by Obamacare. Yes Americans are responsible but they are also rational when it comes to their finances. Obamacare will bankrupt Health insurers and then it will bankrupt the US in totality.

Friday, July 6, 2012

Voter Reality

I often wonder how many registered or for that matter unregistered voters actually have any clue as to what the issues are. It would seem that the vast majority of those who cast a vote do so for popularity or even worse because of what someone else told them. The entire democracy is based upon an expansive game of "telephone." The Politicians get on the tube and say the same things over and over hoping that people will simply believe what is said.

When the media is added to this then the massive population gets the information that fits the story and not the facts as most have come to expect. The media has long gone south on reporting facts, they now have political capital and invested interests to promote. Therefore the voting public is even further from the truth then ever before.

There are no easy answers and the political groups will continue to pander to persuading the majority of simpletons. That is not an indictment of people's intellegence it is a simple fact of life. The reason that scams and frauds are perpetrated on a daily baisis is largely due to people's inability to perform any fact checking at all. The average US citizen will believe anything they hear multiple times and certainly will accept any smooth discourse from respected intellegent authorities.

The reality is that if you read 10 books on any given subject you can pass for an authority on the subject. If you possess an attractive personality you can further envelope large portions of the population into your pitch. The average citizen finds it easier to believe the rhetoric then to do the homework. Pass a rumor around the internet and you have a major news story in the making. If the President gets on the networks and airwaves he starts to promote a way of life. It is no coincendence that the Obama administration has been on the airwaves more than the last 4 Presidencies combined. He and his group is well aware that there is no such thing as over exposure. The methodology has included mass exposure and the overall American population is happy to accept whatever they hear without any fact checking at all. Remember that the reality that has been passed on for eons is that the masses are always willing to accept a big lie. The more repititive the story the more willing the public is to accept it. We have been being told a BIG LIE for the last 4 years and the public is willingly moving towards herd mentality and acceptance of the lie.

TIME TO WAKE UP!

Thursday, July 5, 2012

Psychological Triggers and Investing Behaviors

Human insight is a valuable asset. It is available to all of us, yet very few of us have taken any time to acknowledge the rules of human interests. The most telling rule which basically conditions all others is the absolute fact that people are predominantly self-interested. The bare unadulterated truth is you, just as we all are exist in a world that is generated and perpetrated based upon your own self-interest.

As an investor your behavior is no different, you are driven by your own self-interest. Regardless of what any financial professional, sales professional or professional advisor places in front of you, the underlying motivation is your own self-interest. This very telling aspect of human behavior is one of the psychological triggers that a con-professional will use against you.

 The entire identity of becoming a victim starts with this first rule of human nature. Sadly, as it is universal it makes no difference whether you believe it to be true or not. The telling process is subordinated in your sub-concious and is very easily triggered by any person who has knowledge and experience in using the triggers. Now these very triggers can be used for good or evil and in the essence of the scam, fraud or predatory sales tactic they are used for dishonorable purposes. Seperating a mark from their wealth is never an honorable achievement.

The truth in scams is simply that the victim creates their victimization. This is not a sometimes event it is an ALWAYS event. Therefore all victims can be protected from themselves. In order to be fully insulated and inoculated against scams, fraud and predatory sales tactics you need to know the rules and the psychological triggers. This education will make you fully victim proof.

Tuesday, July 3, 2012

Liberty or Death

"We are a nation that has a government, not a government that has a nation." Those words were spoken by President Reagan back in the 80's. It might has well been the 1880's as we have slowly eroded into a government that is controlling the people and not a government that was meant to serve at the will of its citizens. Just look around you, there are mayors who are dictating what you can eat and drink, because they know better then you on how to care for yourself.

When I can't buy the size BIG Gulp I want then we have gone off the deep end. I personally do not want the government to tell me what to eat, what to wear or how to earn a living. Now the government is going to dictate where and when I get medical care. For those who continue to believe that the motivation to take the least expensive way won't win out, unfortunately are delusional.

Lets look at the realities and how they play out. Take the corporate world first, those who received free passes (exemptions) from Obama will most likely continue to carry health insurance for their employees. The others will do a very simple cost benefit and determine that there is a HUGE savings in not providing benefits and paying a penalty. This is simple math, say it costs 5k per year to provide health benefits and $700 in penalties. As a CEO, CFO or business owner I am ALWAYS going to seek an improved bottom line, this is a business principle. A business exists to make a profit, even non-profit organizations seek ways to improve their expense levels. The bottom line is what shareholders and small business owners are focused on. Obamacare makes an easy decision to the bottom line, money can be saved by cutting benefits and allowing the government to take over the bill for employees health care, that is short and simple. ALl the debate over so-called competition for employees, potential tax laws on penalties, these are all bogus debates. The reality is a major corporation or a small business will make the same decision to improve the bottom line whenever and wherever possible. Any first year business major realizes this, unfortunately we created too many liberal arts majors who graduated college and decided that entreprenurialism and capitalism was a blight on our society. When the lights go out and there is nothing to eat I want to see how Socratic philosophy (PS recently in Greece a group a world wide academics actually spent several days to have a world trial for Socrates and give him a pardon. I'm sure he is happy about that) puts food on the table.

Since Obamacare passed 24 Health Insurers have gone out of business taking with them 10's of thousands of jobs and quite a bit of financial strength as well. This is only the beginning as when the smoke clears the objective is to have a single payer system and only a handful of insurance companies who will be in bed with the government. See how that works out. Forget about competition, health insurance will in essence become a government run monopoly. This won't benefit Physcians, Hospitals or our citizens. No competition equals fixed rates and government subsidies which will begin to set standards of care distribution as well. It will slowly become a triage system and depend on government managed health care. This will determine exactly how you live; don't smoke, don't drink, don't eat foods that might cause you to become obese as determined by the government. How you feed your family, what foods you should buy, what quantities you can consume all will be determined in a packaged government plan. You don't think this can happen do you? Well those who believe that wealth can be distributed and so called equality can be legislated will ultimately see to it that this is the form of government we end up with. I don't believe for a moment that these people want this to be the end game, unfortunately the law of unintended consequences will see this end occur. It is time to wake up and drop party affliations and get away from the left and the right, it is time to stand up for a simple concept that the founding fathers fought for and gifted to us, that simple concept was personal liberty. It doesn't need a political party, but if we were looking for a party affiliation we whould start the party of common sense. Don't sit back and allow the law of unintended consequences destroy our personal liberties, stand up be counted and make America stay on track. Forget the movement towards European soft socialism, and realize that there is never an easy solution and certainly no solutions which create wealth distribution and legislated equality, these systems always end in the same manner. The free enterprise system is the greatest vehicle ever produced for prosperity and each individual has the full and equal opportunity to grow within that system. There are no shortcuts and certainly no government can provide the prosperity that comes with the greatness of the human effort.