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Prosperity by Overcoming Irrational Behaviors Wayne B. Sanders Excelsior College, New York Professor Sharp Try this experiment 1) Say the word “silk” five times as quickly as possible. Silk. Silk. Silk. Silk. Silk. (2) What does a cow drink? Water. A cow drinks water. “Chances are you thought that the answer was milk. Cows drink water. It’s an understandable error. After saying ilk so often in silk, you have primed your brain to think of other words that sound like it. So when you hear cow and drink, it is not a leap to the word milk. You were already “anchored” on ilk words.” Austin(2013) This an example of “Anchoring” which is one of the biases identified in Neuroecomonics that sabotages our investment returns. The DALBAR Study The study shows us that over 20 years the S&P 500 gained on average 9.1% while based on behavior the average investor earned only 3.8% Translated in real dollars if you started out investing with $100 and added another $100 monthly for the next 40 years… At 3.8% after 40 years you would have… $112,916.90 At 9.1% after 40 years you would have… $486,029.64 By taking our emotions out of our investment decisions… Understanding how our brains work can make the “Big Difference” Looking at the Brain Research done using a functional magnetic resonance imaging (fMRI ) machine on twelve Stanford University students from the team of Brian Knutson, Kiefer Katovich, and Gaurav Suri focused on anticipated monetary incentives. The student would press a button based on certain cues that could cause a gain or a loss of amounts of $0.00, $1.00 and $5.00 based on their responses. Findings on the Brain The research allowed the team to distinguish between emotions along two affective dimensions called valence (positive, negative) versus arousal (intensity). The study also included the region of the brain called the nucleus accumbens or NAcc which has a major role in the cognitive processing of motivation, pleasure, and reward and reinforcement learning, and notably an addiction. "Replicating patterns of brain activity previously observed...anticipation of large gains increased NAcc activity...whereas anticipation of both large gains and large losses increased anterior insula activity...For affective ratings, anticipation of large and medium gains increased positive arousal...whereas anticipation of large and medium losses increased negative arousal" (Knutson, Katovich,& Suri, 2014) Fear and Greed our two biggest financial emotions Really? The volatility index or VIX is an indicator of fear maintained by the Chicago Board Options Exchange. It measures the fear of the S&P 500 by looking and factoring in the price of options for the next 30 days. With a higher number, there is a less chance of the market going up. Fear, Greed and the VIX A VIX index was modeled on an open-end equity fund in the Taiwan market. This fund was studied to see the influence of fear and greed on the price of the fund. Data was collected from December 2006 to March 2011. The researchers Chun An Li and Jia Chi Wang were able to show that psychological changes to the investor were correlated to fund performance and that translated to back to the price of the fund. Li and Wang concluded “The greed of investors always lead them to high spirits and made them feel bullish for the future market and results in an increase in stock prices. Meanwhile, fear always means that investors were in a gloomy mood and causes them to feel bearish, resulting in a decrease in stock prices.” How do we achieve greater returns on investment? As you can see over time we are not investing but we are really speculating and getting below average returns with irrational behaviors. What can we do to stop this speculation and improve our returns? We stop “actively” trading and employ “passive” investing. What is Passive investing and why is it better than Active? Passively managedmanaged equity funds are vs. created to are: track a certain market index, Advantages of passively funds active which is a marked difference compared to actively managed equity funds. Cheaper to operate which gives you a much lower expense producing higher returns For example, you may have an index that buys all the stocks from the S&P 500 Moreand taxdoes efficient as they incur less expenses by not trading in and out of not change much from that model. Actively managed funds are stocks created by a fund manager who gets paid to buy and sell different stocks at Overdifferent time passive’s return beats activefor returns as active returns times to“average” try to make the most money a mutual fund portfolio. perform below “average” Example of a simple passive fund portfolio You should have a broad globally diversified portfolio Included are three funds listed here as an example portfolio: Growth Stock Fund Value Stock Fund Foreign Stock Fund Growth Stock Fund 40% Value Stock Fund 40% Foreign Stock Fund 20% Exchange Traded Funds know as ETF can be bought by companies like Vanguard, Fidelity etc… For example for Value Stock Fund you could buy something like Vanguard Russell 2000 Value Index ticker VTWV *Remember to rebalance the percentages at least yearly to keep allocations the same. By employing “passive” investing techniques you will avoid the mistakes of irrational thinking and be on a faster track to prosperity GOOD LUCK!!! 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