Transcript Behavioral Finance - University of Arkansas for Medical

Week 4
Block 10
The Last Week of Medical
School!
Congratulations!
Week Summary
• Monday: Financial Planning, Taxes, Legal
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Matters
Tuesday: Risk Management, Insurance, &
Real Estate
Wednesday: Investing & Saving, Debt
management, Medical Ethics
Thursday: The non-medical practice of
medicine
Friday: Suggestions for Financial & Personal
Success
Week 4 Highlights
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Dr. Edmund Pellegrino- Wed
Private practice panel- Thurs
Dinner- Thurs, Dr. Robert Lewis
Afternoon seminars
Housekeeping
• The test will cover the morning sessions
• Schedule changes:
Thurs PM: Jim Foss on disability
insurance (replaces Broadwater lecture)
• RSVP Thursday dinner
Course Introduction
• Ralph Broadwater, MD
• Rick Caldwell
• Barry Sorrells, MD
Financial Planning and
Investment Success during your
Residency
Ralph Broadwater, MD
Financial Advisor
First Busey Securities, Inc.
Outline
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Keep it practical
Opportunities and Problems
Recommendations
Principles of Investment Success
Behavioral Finance
Questions
Goals during your residency
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Become as well-trained as you can
Develop habits of life-long learning
Have fun
Develop personal habits that make
you sucessful
1. Financial and consumer
2. Personal
Opportunities & Problems
Opportunity
• You will make good money during your
residency
• You will have a great income as a
practicing physician
Resident Salary
UAMS 2003-2004
PGY-1
$36,500
PGY-2
$37,000
PGY-3
$37,500
PGY-4
$38,000
PGY-5
$38,750
PGY-6
$39,750
PGY-7
$41,250
PGY-1 Salary
$36,500/yr
Gross pay
2,979
Taxable Income
2,762
Federal tax withholding
171
State tax withholding
122
FICA Social Security
0
FICA Medicare
0
Insurance (pre-tax)
217
Net take home pay
2,476
Problems
• Consumer lifestyle
• Delayed gratification
• Debt
• Physician retirement problem
• Behavioral factors will reduce investment
success
Class of 2000
Educational Indebtedness
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No debt
debt
134 graduating
$7,042,440
16%
62,879 avg debt
Avg debt
77,334/109,264
84%
Retirement Problem
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$100,000 income
Age 30
Retire at 55 (25 yr career)
2.5% inflation
10% investment return
Live until age 85
Deplete savings in retirement
Savings and retirement
• At age 55 will need to generate
$185,000 for same lifestyle
• Will need $3 million
• If start saving and earn 10% return:
Wealth Accumulation
Typical New MD
• Assumptions
age 30
25 year career (retire at age 55)
• Annual Savings
$30,000/year into Qualified Plan
$1,000/month
• 7-10% investment returns
Monthly savings requirements
Start saving at age:
Per year
Per month
30
30,504
2542
40
94,421
7868
Wealth Accumulation
New MD
Age
7%
8%
10%
35
258,438
266,109
282,056
45
1,129,298
1,231,619
1,467,889
55
2,842,412
3,316,085
4,543,634
65
6,212,365
7,816,290112,521,326
Financial recommendations for
your residency
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Write down your goals
Take care of the basics
Consider buying a home
Consider saving into a Roth IRA
Develop good debt and spending habits
Understand the issues related to investing,
saving, retirement
After residency, hire expert financial help and
be willing to pay for it
Principles of Successful
Investing
• Regular, automatic saving (dollar cost•
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averaging)
Diversify
Maximize tax-deferred saving
Equities focus (growth focus)
Pay attention to fees & taxes
Start saving early
Long-term horizon
Successful Investing
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Slow and steady wins the race
Power of compounding
Power of tax-deferred growth
Maximize both qualified plan and
personal savings
• Annual returns of 7-10%
Barriers to Success
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No clear goals or plan
Inadequate protection (insurance)
Consumption lifestyle
Trying to time the market
Chasing performance
Chasing hot tips
Starting to save too late
Behavioral Finance Issues
Specific suggestions
residency
• Try to save a little
• Save automatically
• Use a balanced no load fund
Vanguard Star
American Balanced
Questions
Break
Behavioral Finance
Daniel Kahneman
Understanding Risk &
Behavior
Enhancing your chances for
investment success
Outline
• Risk
• Investor Behavior
Information Sources
• Investment Policy: How to Win the
Loser’s Game, Charles D. Ellis
• Why Smart People Make Big Money
Mistakes, Gary Blesky & Thomas
Gilovich
• www.undiscoveredmanagers.com
What is risk?
Most people confuse risk with
volatility
AOL
Volatility
• Short term variation in price
• Not really important or meaningful
• Real issue: What is the long term trend?
• Investing is a long-term process (>10
years)
Long term trend
AOL
Understand the difference
between short-term volatility
and long term trends
S&P 500
Short term performance
S&P 500
Long term performance
What is true risk?
Risk
• Not insuring for unexpected catastrophe
• Not saving enough to retire
• Not keeping place with inflation
• Outliving your money
• Your behavior may prevent investment
success
Behavioral Finance
• Your behavior will inhibit financial
success
• Examples
Mental Accounting
• We value some dollars less than others
and waste them
• $1=$1
• Examples:
Lamp and dining room set
Credit card purchases
Lamp and dining room set
• You go to a store to buy
a lamp that sells for
$100
• You go to a store to buy
a dining room set that
sells for $1775
• The lamp is for sale at
• The lamp is for sale at
branch store 2 miles
away for $75
branch store 2 miles
away for $1750
• Do you go to the other
• Do you go to the other
branch?
branch?
Credit Card purchases
• Draze & Simester, MIT
• Study
• Real life, sealed bid auction for Boston
Celtics tickets
• ½ told have to pay with cash
• ½ told could pay with credit card
The average credit card bid
was roughly 2x as large as the
average cash bid!
Solutions to Mental Accounting
• $1 is $1
• Treat credit card purchases the same as cash
purchases
• Use it to your advantage
Rick Adkins suggestion separate account for
non-routine expenses
Separate savings account
Loss Aversion
• Feel the pain of loss more acutely than
the reward of gain
• Odean study
Stock account analysis
• Terrance Odean
• Analyzed trading records of 10,000
accounts at major discount brokerage
• 1987-1993
• Interesting findings
Odean Study
• Investors were more likely to sell
winners than losers
• The stocks the investors sold
outperformed the stocks they held by
3.4% over the next 12 months
• People tend to hold losers too long and
sell winners too soon
Minimize Loss Aversion
• Diversify
• Professional help
• Sell losers
• Investment Policy Statement (IPS)
Choice Under Conflict
• The more choices you have the more
likely you are to do nothing
• Examples
Jam study
Tversky study
Mutual funds
Sethi & Lepper Jam study
• 6 jams
• Coupon $1 off
• Tasting
• 24 jams
• Coupon $1 off
• Tasting
• Track purchases
• Track purchases
Jam study results
• 6 jams
• 24 jams
• 30% made a
• 3% made a
purchase
purchase
There are 14,674 mutual
funds
Morningstar database
Tversky study
• Students offered $5 reward for
answering and returning a long survey
• Different groups
• 5d, 21d, no deadline
Tversky study results
deadline
% returned
5 days
66%
21 days
40%
No deadline
25%
Minimize Choice Under
Conflict
• Understand that the more choices you
have the harder it is to make a decision
• Understand that no decision is a
decision
• Create deadlines
• Get help
Minimizing Risk
• Have a long-term view
• Diversify
• Start saving early
• Invest mainly in stocks
• Understand how your behavior may
inhibit your success
• Hire expertise
10 Guidelines for Success
1. Identify your goals
2. Identify your risk tolerance
3. Develop an Investment Policy
Statement (IPS)
4. Take care of the basics
5. Be aware of behavioral barriers to your
success
10 Guidelines for success
6. Diversify
7. Follow your IPS
8. Monitor your progress
9. Pay attention to the cost of investing
and taxes
10. Be willing to pay for expertise
Questions
Individual Sessions
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Dr. Broadwater
Starting April 21
Call 686-5547
Email: [email protected]
Investment Policy Statement
(IPS)
• Formal investment plan (not a contract)
• defines
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goals
investment vehicles
expected returns and risk
Outlines
how investments are selected
how changes will be made
reporting
Total Annual Returns
1926-1996
Small company
stocks
Large company
stocks
Corp Bonds
14
12
10
8
6
4
Govt. Bonds
U.S. Treasury Bills
2
0
% return
Inflation
Message:
To beat inflation you need to
invest in stocks.
Compound Returns
1982-1990
18%
12%
8%
5%
S&P 500
Less 20 biggest days
Less 10 biggest days
Less 30 biggest days
Message:
You cannot time the market. (You
always need to be fully invested)
Asset Class Winners and Losers
1986
1987
1988
Internat’l
Stocks
HIGHEST
RETURN
1989
1990
Large
Stocks
30 Day
T-Bills
LT Gov’t 30 Day Small
Bonds T-Bills Stocks
Large
Stocks
Small
Stocks
LOWEST
RETURN
LT Gov’t
Bonds
1992
1993
Small
Stocks
1994
1995
Internat’l
Stocks
1996
Small
Stocks
Large LT Gov’t Small 30 Day
Stocks Bonds Stocks T-Bills
30 Day
T-Bills
Internat’l 30 Day
Stocks T-Bills
Large
Stocks
1997
1998
Internat’l
Stocks
Small
Stocks
Internat’l
Stocks
1999
2000
Small LT Gov’t
Stocks Bonds
Large
Stocks
Internat’l Large LT Gov’t Large LT Gov’t Small LT Gov’t Internat’l
Stocks Stocks Bonds Stocks Bonds Stocks Bonds Stocks
LT Gov’t
Bonds
30 Day Small
T-Bills Stocks
1991
LT Gov’t
Bonds
30 Day
T-Bills
Large
Stocks
30 Day
T-Bills
Small
Stocks
Large
Stocks
Internat’l 30 Day Internat’l 30 Day LT Gov’t 30 Day LT Gov’t Internat’l Small LT Gov’t Internat’l
Stocks T-Bills Stocks T-Bills Bonds T-Bills Bonds Stocks Stocks Bonds Stocks
This is for illustrative purposes only and not indicative of any investment.
Past performance is no guarantee of future results. 1/1/2001.
Copyright © 2000 Ibbotson Associates, Inc.
Message:
You need to diversify.
(Don’t put your eggs in one
basket)
U.S. Market Recovery after Tragedy
Cumulative return of the S&P 500 after tragic events
90%
81.4%
70%
After 1 month
After 6 months
After 1 year
After 3 years
57.7%
56.6%
50%
26.9%
30%
20.3%
18.9%
20.9%
15.9%
11.4%
10%
2.6%
1.6%
2.2%
6.1%
8.3%
-1.0%
-4.9%
-10%
-30%
Dec 7, 1941
Pearl Harbor
Nov 22, 1963
President Kennedy
assassinated
Aug 2, 1990
Iraq invades Kuwait
Feb 26, 1993
World Trade Center
bombed
Message:
Always stay fully invested.
Comparing Returns Between Investments
$350,000
$200,000
Inflation $29,550
Cash
$46,769
Bonds
$84,030
Stocks $321,894
$150,000
Initial Investment $10,000
$300,000
$250,000
$100,000
$50,000
$0
1976
1979
1982
1985
1988
1991
1994
1997
Risk of Poor Market Timing
$90
$75
$83.22
$60
12.34%
Average Return
$45
$30
$15
$21.85
8.69%
$0
Average Return
Bad Market Timing
(Miss 12 Best Months)
Buy and Hold
(Fully Invested
At All Times)
Monthly Stock Returns from 1960 through 1998
Benefit of Long-Term Saving
Accumulated
Savings
$1,000,000
Savings Goal $1,000,000
$1,052 per month
$1,698 per month
$2,890 per month
$5,466 per month
$13,610 per month
$800,000
$600,000
$400,000
$200,000
$0
25
20
15
10
Years Until Savings Goal
5
0
Power of Compounding
$120,000
Assumed Annual Return:
4%
$100,000
8%
$108,347
10%
$80,000
$68,485
$60,000
$40,000
$20,000
$0
$26,658
5 Years
Initial
Investment
$10,000
10 Years 15 Years 20 Years 25 Years
Power of Tax Deferral
Currently Taxable
Tax Deferred
$50,000
$49,185
$40,000
$36,889
$30,000
$20,000
$10,000
$0
5 Years
Initial
Investment
$10,000
10 Years 15 Years 20 Years 25 Years
Uncertainty and Investment Risk
1974
-30%
1973
-20%
1990
1981
1977
1969
1966
1962
-10%
1994
1992
1987
1984
1978
1970
1960
1993
1988
1986
1979
1972
1971
1968
1965
1964
1998
1996
1983
1982
1976
1967
1963
1961
0%
10%
20%
Annual Stock Returns
1997
1995
1991
1989
1985
1980
1975
30%
40%
Inflation and Purchasing Power
$1.00
$0.50
34¢
$0.00
1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998
Advantage of Long-Term Investing
80%
Stocks
Bonds
Cash
Annual Returns 1976 - 1998
60%
Range
of
Annual
Return
40%
20%
0%
-20%
Any 1
Year
Short
Over 3
Years
Over 5
Years
Holding Period
Over 10
Years
Over 15
Years
Long
What Drives Portfolio Performance
Asset Allocation
91.5%
Other Factors 2.1%
Market Timing 1.8%
Security Selection 4.6%
Relationship Between Risk and Return
High
Int’l Stocks
Stocks
Expected
Return
Real Estate
Int’l Bonds
Bonds
Low
Cash
Equivalents
Low
Risk
High
Diversification from Combining Investments
No Diversification
Complete Diversification
Portfolio 1
Portfolio 2
Investment A
Investment C
Investment D
Investment B
Some Diversification
Investment E
Portfolio 3
Investment F
Identifying “Efficient” Portfolios
High
Same Risk,
More Return
Efficient
Frontier
Expected
Return
Inefficient
Portfolio
Same Return,
Less Risk
Low
Low
Risk
High
Selecting a Suitable Portfolio
High
Expected
Return
Cash Equivalents
Gov’t/Corp Bonds
Int'l Bonds
Real Estate
Large Cap Stocks
Europe Stocks
Pacific Stocks
Small Cap Stocks
Low
Low
Risk
High
Five Sample Portfolios
Portfolio 1:
Conservative
Portfolio 2:
Moderately
Conservative
Portfolio 3:
Moderate
Portfolio 5:
Aggressive
Portfolio 4:
Moderately
Aggressive
Stocks
Bonds
Cash
Do you have a formal
investment plan, the goal of
which is to allow your income
potentially to triple during your
retirement?
The cost of living will triple
1975 10¢
2001 34¢
Change in Price
1975-2001
Cost of a stamp
+340%
S&P 500 cash dividend
+450%
Absolute level S&P
500
+1200%
10 yr. Treasury yield
-33%
Power of Compounding
Assumed Annual Return:
$120,000
4%
8%
$108,347
10%
$100,000
$80,000
$68,485
$60,000
$40,000
$20,000
$26,658
$0
5 Years
Initial
Investment
$10,000
10 Years 15 Years 20 Years 25 Years
Questions