Judgment in Managerial Decision Making 8e

Chapter 9Common Investment Mistakes

Copyright 2013 John Wiley & Sons

Active Fund Management

• 25% of funds outperform market• Past performance poorly predicts future• Returns limited by high fees• Hedge funds

The Psychology of Poor Investment Decisions

• Overconfidence• Optimism• Denying random events• Anchoring, status quo, and procrastination• Selling winners and keeping losers

Overconfidence Produces Excessive Trading

• Frequent transactions increase costs• Transactions are becoming more frequent• Active investors underperform the market• Men trade more than women

Optimism about Investment Decisions

• Optimistic predictions of fund performance• Optimistic recollections of past performance

Denying that Random Events are Random

• Underweighting randomness• Neglecting regression to the mean• Limited evidence of consistent performance– Momentum effect– Performance reversals in outliers

Anchoring, the Status Quo, and Procrastination

• Retirement plans– Failing to change risk allocations– Arbitrary options influence risk allocations

• Sticking to the status quo• Failure to “opt-in”

Prospect Theory, Selling Winners, and Keeping Losers

• Selling winners• Keeping losers• Impact on returns

Active Trading

• The rise of online trading• Initial success stories• Underperforming the market• Considering other traders

Action Steps

• Determine your investment goals– Save enough for retirement– Embrace risk now– Reduce risk later– Invest in annuities

• Difficulty predicting the stock market• Putting this information to use– Avoid unnecessary fees– Consider tax issues