A couple of weeks ago, I wrote a column about the growing tribe of people who value experiences over security in their lives. But there is something that I didn’t say then that I want to emphasize: You don’t necessarily have to trade experience and financial security off against each other. One of my main…
Of all the misinformation disseminated to investors, the most pernicious supports the belief that some “investment pro” or pundit has the skill to reliably pick outperforming stocks. This myth is perpetuated by endless blogs and television appearances by “gurus” touting their latest and greatest stock selections. A steady drumbeat Read the rest of the article…
Last week, we examined a study that found investors’ risk tolerance fluctuates positively with recent market returns. This behavior is in direct conflict with rational economic theory, which dictates that when market returns become negative, wealth contracts and risk aversion should therefore decrease (while risk tolerance should increase). Instead, the authors found that investment losses,…
Behavioral finance is the study of human behavior and how that behavior leads to investment errors, including the mispricing of assets. Among the many behavioral biases well-documented in the literature is “local” bias—individual investors tend to invest more in stocks that are close to home. There’s also evidence that local bias extends to the behavior…
Many investors and advisors who implement multifactor portfolios tend to focus on capturing the value premium over the size premium, often for the simple reason that, historically, the value premium has been larger. Others have even challenged the size premium’s very existence, citing a weak and varying historical record. In both situations, it may be…
The recency effect—that the most recent observations have the largest impact on an individual’s memory and, consequently, on perception—is a well-documented cognitive bias. This bias could impact investment behavior if individuals focus only on the most recent returns and project them into the future. Such behavior may lead investors to experience a reduction in their…
I want to talk to you about scary markets. For the sake of this particular subject, I want to be blunt and a little bit in your face. So for the next few minutes, please, just think of me less as your friend and more as your Scary Markets Drill Sergeant. O.K.? Great. Now, you…
Initial public offerings (IPOs) involve a great deal of uncertainty, which makes them a relatively risky investment. Thus, investors should receive higher expected returns as compensation for the greater amount of risk that’s associated with them. However, the evidence shows that unless you are well-connected enough to receive an allocation at the IPO price (and…
For about three decades, the working asset pricing model was the capital asset pricing model (CAPM), with beta—specifically market beta—being its sole factor. Then, in 1993, the Fama-French three-factor model—which added size and value—replaced the CAPM as the workhorse model. By eliminating two major anomalies (the outperformance of small stocks and of value stocks), it…
What do the following investments have in common? Options Covered calls Collateralized mortgage obligations Non-traded REITs Master limited partnerships Variable annuities Equity-indexed annuities Hedge funds Principal protected notes Private equity Here’s the answer: They are all complex investments. As a result, assessing the risks involved with owning these investments can be challenging. They also generate…
One of the interesting puzzles in finance is that stocks with greater idiosyncratic volatility (IVOL) have produced lower returns. This is an anomaly, because idiosyncratic volatility is viewed as a risk factor—greater volatility should be rewarded with higher, not lower, returns. Robert Stambaugh, Jianfeng Yu and Yu Yuan, authors of the study “Arbitrage Asymmetry and…
Haim Mozes and John Launny Steffens, authors of the study “Getting More Value Out of the Value Factor,” which was published in The Journal of Investing’s Winter 2015 issue, have attempted to create a model that can accurately predict the performance of the value premium. The factors in their model include analysts’ long-term earnings growth…
One of the questions I’m most often asked by reporters covering finance is: “What are the biggest risks facing investors?” My usual response is that the biggest risk confronting most investors is staring right back at them when they look in the mirror. And there’s plenty of academic research to support that view. Much of…
In life, there are certain nonnegotiables we simply must have. Think food, water and shelter for starters. Nobody will ask, “Is it worth it to eat?” It’s just something you do to stay alive. But deciding what to eat? That’s a different question. Will I eat the bologna or prosciutto? Drink tap water or bottled?…
The Shiller cyclically adjusted (for inflation) price-to-earnings ratio—referred to as the CAPE 10 because it averages the last 10 years’ earnings and adjusts them for inflation—is a metric used by many to determine whether the market is undervalued, fairly valued or overvalued. Employing a 10-year average for earnings, instead of the most current 12-month earnings,…
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