Outsmart yourself!

Invest wisely using “Behavioral Finance” insights

 Behavioral finance

Content

4 Outsmart yourself! Invest wisely using “Behavioral Finance” insights

4 Know yourself!
6 The self and the brain
7 Brain – money – profit
7 Over-estimation of one’s own abilities (hubris)
9 Heuristic simplification / information processing errors
14 Emotion / affect
15 Social
16 Outsmart yourself!

Allianz Global Investors GmbH

Bockenheimer Landstr. 42 – 44
60323 Frankfurt am Main

Dr Hans-Jörg Naumer (hjn)

September 2022

Data origin – if not otherwise noted:

Thomson Reuters Datastream

Allianz Global Investors

www.twitter.com / AllianzGI_VIEW

3
Behavioral finance

Outsmart yourself!
Invest wisely using
“Behavioral Finance”
insights
Every person is homo œconomicus and as such
makes purely rational decisions. The result of this
is efficient capital markets. Is this true?

Know yourself! made decisions purely as rational “homo œco- 1

Kahneman,
nomicus”1. They could identify behavioral pat- Daniel / Tversky,
Behavioral finance is an approach that is gaining terns that are simply not explicable rationally. Amos, Prospect
increasing popularity in capital investments. But The Prospect Theory may have gained currency theory: An analysis of
what lies behind it and how can it be used for in ­financial economics through Richard Thaler, decision under risk.
In: Econometrica,
investors? who applied Kahneman and Tversky’s insights to Band 47, 1979, S.
capital investments, from which the Behavioral 263–292
It is based on the work of Daniel Kahneman and ­Finance Theory then emerged. 2 . 2
Thaler, Richard
Amos Tversky, who with their “Prospect Theory” (Hrsg.): Advances in
Behavioral Finance.
formulated from a psychological perspective an Band I, Russell Sage
alternative to the current hypothesis that people Foundation, 1993

Decisive insights:
– Investors are only human too. Their decisions are not exclusively rational. On the contrary.

– They tend towards typical behavioral patterns which are reflected in stock exchange prices.

– Behavioral anomalies lead to inefficient markets. These are not only an argument in favour
of active management, but can also be used purposefully.

– Whoever recognises this can outsmart themselves and make better, more rational invest-
ment decisions.

– The science of Behavioral Finance provides the foundation for this self-realisation.

4
 Behavioral finance

Behavioral Finance-Theory classification

“Behavioral Economics” deals with irrational human behaviour in economic situations. Above all,
it tries to resolve the assumption of homo œconomicus, the rational minded and thinking person.
Observed behaviour usually contradicts the predictions of classic economic models, which is
why Behavioral Economics searches for clarification of this irrational behaviour. Such behaviour
can be observed across all life situations, which is why a broad, empirically-based literature has
formed. In addition a multitude of theoretical models exist that can always explain specific
behavioral anomalies.

Source: Wikipedia.org

The basic premise of Behavioral Finance is Thus behavioral finance is interesting for investors
that investors tend towards “anomalies”, that is, because:
towards non-rationally explicable behavioral
patterns or tendencies, which are reflected in – Anyone who can identify typical behavioral
their investment decisions and in the prices of flaws in themselves can not only optimise his or
securities and on the stock exchanges. Therefore her own decisions but can also learn from the
there are no purely rational investment decisions mistakes resulting from inefficiencies of others;
which, according to the opposite premise, lead to and
efficient markets. On the contrary: inefficiencies
happen consistently. – anomalies are an important criteria for active
management. Only those who believe that
markets are always completely rational and
that prices include all information available,
can rely on passive management, meaning
blind investment in benchmarks.

“Anyone who can identify typical behavioral

flaws in themselves can not only optimise his or
her own decisions but can also learn from the
mistakes resulting from inefficiencies of others.”

5
Behavioral finance

The self and the brain

The emotional, limbic system is the older part
The composition of the brain is the product of of the brain. We needed emotions for survival
over millions of years of constant evolu tion. In its before we needed logic. It works very quickly
current form it originated in the stone age world and, like computer circuits, in parallel.
with its needs to hunt, and the need for life in a
manageable clan. On the basis of the needs of The cortex is responsible for logic. It works slower
that time its basic structure can hardly be ideal and serially, in other words it solves tasks consec-
for the modern age with its complexity. utively not simultaneously.

Cerebral research stems from three centres in the The two halves of the brain, equally important for
brain, which have developed differently and inter- decisions, do work very differently but function
act to some extent very differently:3 ­together. The combined halves of the brain form
two systems by means of neural circuits through
– the cortex, in which logic is anchored, which both goal-oriented behavioral patterns
– the limbic system, responsible for emotions, are controlled:
as well as
– the in-between recumbent part of the brain – Pursuit of reward and
(the part similar to the brain of reptiles) which – Loss prevention.
controls basic bodily functions, in which breath-
ing and the heartbeat are also included. It is The old exaggerated saying comes into effect
not relevant for our further observations. here: Stock markets shift constantly between
greed and fear – the two extremes of the pursuit
The anterior part of the cortex (the prefrontal of reward and loss prevention.
­cortex) is responsible for learning, logical thinking,
planning, calculating and making strategic deci- Anxiety, fear, panic – these are all feelings that 3
 rain structure
B
sions. come from the loss prevention system. The system according to Paul D.
for striving for reward helps us to assess potential MacLean, also
The limbic system is responsible for the more prospects and strive for advantages. It is control­ compare Goldberg,
primitive motivations and emotions such as fear led via the neurotransmitter dopamine and can Joachim / von
Nitzsch, Behavioral
and excitement. therefore be manipulated by a lack or surplus of Finance, S. 165ff.
dopamine.

Self-test: Feel good in 60 seconds! Carriers

For a long time it was believed that Neurotransmitters, such as serotonin and
­emotions resulted from certain events. You dopamine are responsible for the exchange
feel good for example because you have of information between the brain’s neurons.
executed a successful investment. However, Depending on whether these chemical
the reverse is also true: Emotions can be ­messengers assist or curtail the flow of
produced by specific behaviour. Try it! Take ­information between the neurons, they
a pencil between your teeth and smile at ­influence our opinions and our reasoning
the same time. After about 60 seconds you powers as an investor. Among other things
will feel happier. they influence cognition, processing and
the evaluation of information.

Added to this are other active agents such

as opioids, noradrelanine, stress hormones
and omega-3-fatty acids.

Pathological disturbances, medication and

drugs (including alcohol) as well as caffeine
impact on these chemical processes and
­also affect human behaviour.

6
 Behavioral finance

Brain – money – profit Over-estimation of one’s own

abilities (hubris)
If only we were always rational, we would make
the best decisions and optimise our financial “One only becomes clever from mistakes – one
investment free from emotions. We would then mistake is not enough.” The deep wisdom in this
be what economic textbooks imply: offhand saying is its assumption: we learn from
A homo œconomicus. our mistakes. But learning from mistakes also
includes impartiality when recognising mistakes,
There is indeed an economist in every one of us, to acknowledge them in order not to perpetrate
because we constantly make economic decisions them again. Frequently, however, an over-estima-
that promise us the best advantage (for example: tion of one’s own abilities stands in the way of this
get up in the mornings and earn money instead learning mechanism: what worked well is our suc-
of staying in bed), but we are not computers that cess. What fails, well, that was simply bad luck or
can process all of the information, form an emo- bad advice. Hubris also obstructs vision in invest-
tion-free utility function and finally make the opti- ment decisions. In the process, this thinking mech-
mum decision. anism willingly gathers momentum following
­initial results that are then credited to one’s own “Part Man, Part
We carry our history of development around with prowess. The consequences can be disastrous. Monkey?“
us, which was helpful to us out in the wild and on
the hunt, but which is in modern society not The most common mistakes resulting from hubris
always beneficial. We combine logical thinking are over-optimism and overconfidence. Both ten-
with resulting behavioral patterns from the Stone dencies are accompanied by an illusion of control
Age that enabled the survival our ancestors at and an illusion of knowledge, meaning it is
that time. We are, as James Montier disparag- assumed one is able to control a development
ingly expressed, “Part Man, Part Monkey”.4 that is not controllable, or that one possesses suf-
ficient knowledge for decision making – which is
Behavioral finance has derived typical behav- however not the case. In the long run it can even
ioral patterns from this realisation. Someone who involve random developments which are neither
knows these patterns is a step further not only controllable nor predictable but whose result the
with self-awareness, but is already on the way to investor attributes to his or her own knowledge.
outsmarting themselves. But this is disastrous: with increasing illusion of
control the willingness to absorb new information
Hirschleifer here differentiates four super-ordi- and evaluate one’s opinion decreases. A spiral
nate investor behavioral pattern / tendencies, evolves quickly following initial investment suc-
which are further subdivided into their resulting cesses, according to the pattern “delight – greed
behavioral patterns (compare figure 1):5 – euphoria – collapse”.

4
 ontier 2002
M
5
Hirschleifer, David (2001), “Investor Psychology and Asset
Pricing”, Journal of Finance 56, quoted and adapted slightly
from James Montier (2002) “Part Man, Part Monkey”,
Dresdner Kleinwort “Global Equity Strategy”.

The structure of our brain, our thought processes, control via neurotrans-
mitters have however an immediate effect on how we invest our money
and what profit (or loss) we can make. The pursuit of reward and the
prevention of losses override all our behavioral patterns.

7
Behavioral finance

“The greatest obstacle to discoveries is not

­ignorance– it is the illusion of knowledge.“
(Daniel Boorstin)

Ask among your colleagues, who in this group One’s own powers of recollection can also pull
rank themselves among the below-average, who the wool over the eyes of investors. As a general
among the average and who among above-av- rule losses are gladly forgotten, while profits
erage drivers. Because everyone orientates them- remain stuck in one‘s mind. Also a consequence
selves to an assumed average, the result would of over-estimating one’s own abilities.
have to be a normal distribution around an aver-
age value. Presumably however, more than 50 % An over-estimation of one’s own abilities can eas-
of your colleagues rank themselves among the ily lead to a conservatism bias: instead of rethink-
above-average operators – which by definition ing old forecasts, they are maintained and
cannot be true. adapted to the reality, with only a delay in time.

You can also ask school classes or course partici- The yearning for (self) affirmation is also danger-
pants in educational establishments, who expect ous. With this only the information that corre-
themselves to be passed as above-average. sponds to the existing assessment is taken into
Here too, one can expect more than half to rank account. Conflicting information is suppressed
themselves among those who will pass as above-­ or is designated as less important.
average.
Cognitive dissonances that can occur if new,
Overconfidence, associated with illusion of con- uncomfortable truths appear and should have
trol and knowledge, can also happen in capital some influence on the investment decision pro-
investment. Anyone who looks back on a series cess , also often lead to suppression. The gist is:
of successful investments will tend to believe I do not need to take into consideration what
that in the future he or she will be able to antici- does not suit me.
pate markets accurately. It is precisely in a bullish
phase on the capital markets that there is a
very real danger of crediting oneself with above-­
average aptitude in financial investment. But
what is above average, when everything is going
well – and what happens when a slump in the
bull m
­ arket ensues?

8
 Behavioral finance

Hindsight bias Heuristic simplification/

With the benefit of hindsight, everything appears information processing errors
to be “crystal clear”: The development of market
indicators and of equity prices – anyone who Heuristic simplifications are rules of thumb for
knows the charts thinks: “How could it have been progressing through the jungle of information.
different? I knew that.” Even the stock market Frequently they are fully meaningful shortcuts en
crash that began in 2000 seems today to be route to decision making. They can however also
­predictable and virtually logical. But who could lead to incorrect results. These mistakes are dis-
have accurately predicted it before the bursting cussed here.
of the bubble? The danger of this tendency lies
primarily in the over-estimation of one’s own abi­ Representativeness
lities: Someone who believes that he could have Representativeness has to do with the signifi-
foreseen a lot in the past will also mistakenly cance of random samples in relation to the total-
­presume this in the future. ity from which they are taken. Often this signifi-
cance is overestimated and the laws of proba­
bility are accordingly rendered inoperative.

Figure 1: A classification of typical sources of error adapted from behavioral finance theory

Biases

Heuristic simplification
Self deception
(Information processing Emotion & Affect Social
(Limits to learning)
errors)
Overoptimism Illusion of
control Illusion of knowl- Representativeness Mood Imitation
edge

Overconfidence Framing Self control Contagion

Self Attribution bias Anchoring Fear & Greed Herding

Confirmation bias Availability bias Regret Cascades

Hindsight bias Cue competition

Loss aversion /
Cognitive dissonance
Prospect theory

Conservatism bias

Based on David Hirschleifer (2001), “Investor Psychology and Asset Pricing”

9
Behavioral finance

Figure 2: The animal rights activist and the bank clerk

The animal rights activist and the bank clerk

Bank clerk Animal rights activist

James Montier illustrated that with an example6 Framing7

(adapted slightly): Often investors allow their vision to become
restricted by inadequate information. The win-
Imagine that a woman takes her philosophy dow, or rather the window-frame, through which
exams and applies for a job. Throughout her they observe the investment world, is simply not
studies she is a great champion of the protection large enough, to be able to review all the perti-
of animals. nent information and at the same time identify
investment alternatives or contradictory facts.
What is more probable? That she Frequently investments are made on the sum-
mary story, without analysing how long it will
a) becomes a bank clerk last or whether there might not be other, better
or ­prospects.
b) becomes a bank clerk and an animal rights
activist? Information cognition and information accep-
tance are different, depending on whether the
Answer “b” would normally be selected. Never- information is consonant or dissonant with one‘s
theless, this judgement runs contrary to probabil- own attitude. Here the rule is: the more informa-
ity. In terms of the entire population, bank clerks tion conforms to one’s personal views the more
as well as animal rights activists make up only likely it will be accepted.
a small proportion. Therefore to combine both,
in other words to form an intersection of both, is A good example of investments that select only
clearly more improbable than simply to have well-established alternatives, not all potential
one of either attribute alternatives, is usually the purchase of rental
(Figure 2). properties. Given that the street just opposite
is better known, the apartment complex there
For investment decisions the false assessment is purchased for rental purposes, instead of find-
of representativeness is also important. Success- ing prospects in other countries or even on other
ful companies like to assume that they will con- ­continents.
tinue to be so in the future. Successful companies
do not however, have to be necessarily represen-
tative of future high profits. Often, according to
Montier, a return of profit growth back down to
average is observed. So anyone who is blinded
by current high profits will quickly make a careless
investment decision.

6
 ontier (2002b) p. 6
M
7
see also: Kahneman, Daniel / Tversky, Amos, Rational Choice and the Framing of Decisions, Journal of Business 59, p. 251–78

10
 Behavioral finance

Often investors allow their vision to become ­restricted

by inadequate information. The window, or rather the
window-frame, through which they observe the invest-
ment world, is simply not large enough, to be able to
review all the pertinent information.

The frequently observed “Home Bias” is another Anchoring

classic case of Framing: Since local-shares are People will also be inclined to combine their
known by the majority of investors, the amount of assessment with – completely irrelevant –
domestic shares in investor accounts is clearly “anchors” in their memory.
higher than their share of the actual global mar-
ket capitalization. Tversky and Kahneman proved this as early as
1974 with their study that gained fame.9 They
Consequence: poor diversification and the block- asked their test subjects general knowledge
ing out of better alternatives. questions, for example: “How many UN-member
states are from Africa?” and showed them before-
The deposit itself is not only badly diversified, the hand numbers generated using a wheel of for-
returns on human and financial capital also cor- tune. But the wheel of fortune itself was manipu-
relate stronger than necessary, because an inves- lated and produced either “10” or “65”. The result
tor’s salary is more closely connected with the was unanimous: people who had seen the num-
return on domestic shares than with the return on ber 10 prior to the survey gave a markedly lower
foreign shares.8 figure than people who had seen the number 65

8
Von Nitzsch / Stolz, Zu welchen Renditeeinbußen führt der Home Bias?, in: FiFAM Foschungsbericht 04 / 05, S. 3
9
Kahneman, Daniel / Tversky, Amos. Judgment under uncertainty: Heuristics and biases. Science 185 (4157): p. 1124–1131

11
Behavioral finance

You offer a child three pieces of chewing gum,

but tomorrow he will get five if he turns them down
today. How does the child decide?

previously. Yet the responses to these questions Disastrous: This is why securing the future, too,
had absolutely nothing to do with either of these is willingly put off until tomorrow, even though
numbers. the compound interest effect from early saving How many of your
has an enormous effect. Sacrifice today is experi- good intentions at the
start of the year have
These characteristics also explain why forecasts enced as more painful than retirement tomorrow you kept?
are frequently given following the last prices as without worry. Someone who saves today needs
the reference figure. For example: the current to put aside considerably less tomorrow.
price of shares is the anchor for formation of
expectations. In actual fact the price should be
calculated on the basis of profit estimates time
Anchoring with a reference value
and again, using for example a Dividend-­
Discount-Model valuation method.
Orientation to an (arbitrary and therefore
Availability bias in most cases incorrect) reference value,
Be honest: How many of your good intentions at namely the purchase price, following the
the start of the year have you kept – and for how slogan “I will wait until the value increases
long? again and I can sell without loss”, is incorrect
on three counts: not only because the instru-
Typically we fail our good intentions quickly, ment can lose value even further, but
because the realisation of the advantage because in the meantime you miss out on
expected from it lies in the future and the better investment opportunities and at the
future is uncertain, and because we prefer the same time lose purchasing power because
quickest, most secure profit, current convenience, of inflation.
or immediate advantages.

So why go jogging, give up desserts or stop

­smoking now, if the expected fruits of this
Self-test availability bias
endeavour for one‘s own health and longer life
are in the future? Enjoyment will come before
the better life tomorrow. That is reminiscent of You offer a child three pieces of chewing
a hunter, who immediately consumes his prey, gum, but tomorrow he will get five if he turns
because he does not know whether he will be them down today. How does the child
alive tomorrow or not. decide?

Due to the preference for benefits today by €100.00 is offered to you today. How many
­implication the benefit expected tomorrow is euros would have to be offered to you for
­discounted in value. That is quite clever, but you to refuse the money now and wait a
clearly the discount factor is so high that the year? Compare the return from it with the
­benefits expected tomorrow no longer bear return from a secure financial investment.
any ­significance.

12
FIFAM (“Research Institute for Asset Manage- economy at the beginning of the 90s,
ment”) has come to the conclusion that threat- ­globalisation gained in intensity. But in the case
ened poverty in old age is considered as hardly a of the fall of the Wall we can remember much
threat.10 Many considered this risk as controllable more clearly, because the key stimulus was
and harmless in comparison with other risks. appreciably greater.
Three very unfortunate behavioral patterns
may coincide here: According to what criteria do you choose the
securities you invest in? Is there a stringent selec-
– Illusion of control tion process at the outset or is the insistent way
– Suppression of cognitive dissonances many of your stocks appear in the printed media?
– Time preference It is interesting to know that yields on shares and
press reports are closely connected – negatively.
Instead of maximising the cash equivalent of Gadarowski discovered that shares which are
one’s entire lifetime income, the here and now ­frequently mentioned in the press in one year,
is overrated to the detriment of securing one’s only generated below-average returns in the
future. ­following two years.11

Cue competition Loss aversion

The intensity with which we absorb information Someone offers to play a game with you with a
and the probability with which we will remember coin. If you lose, you must pay €100. What profit
it increases according to the intensity of the key would it take for you to be willing to get involved
stimulus that makes us absorb the information. in the game?
There is no correct answer in this case. It depends
Do you still remember where you were on on your propensity for risk. If you accepted a
9 November 1989? Presumably you remember profit of €100.00 from the game you would
precisely where you were and what you felt on be risk-neutral. As a rule, how ever, people get
the day the wall in Berlin fell. involved when they can win more than the poten-
tial loss. People have an aversion to loss. They
But can you also remember when India turned want to keep what is theirs. This often leads to a
towards the global market and turned towards displacement effect with financial investment.
a market economy? It was in 1991. Securities that perform worse than expected are
not sold, and remain in the account. “It’s hap-
Both events occurred around the same time in pened again”, is the attitude. Losses are only
the past and had enormous economic and politi- accepted reluctantly.
cal significance. With India’s change to a market

10
Von Nitzsch / Hackethal, Kundennutzenorientierte Gestaltung der Anlageberatung im Privatkundengeschäft,
In: FiFAM Forschungsbericht 05 / 05, S. 9
11
Gadarowski, Christopher (2002) “Financial Press Coverage and Expected Stock Returns”, Rowan University

13
Behavioral finance

Figure 3: Loss aversion and propensity to invest

Net sales of mutual funds in Germany and development of the DAX

15.000 20.000

10.000
15.000
5.000

0 10.000

–5.000
5.000
–10.000

–15.000 0
1995 2000 2005 2010 2015 2020
NMA German Mutual Funds DAX (Right scale)

Source: Datastream; Allianz GI Global Capital Markets & Thematic Research and Deutsche
Bundesbank .1 Funds raised by mutual funds companies from mutual funds in Germany.
Data as of August 2022

People are creatures of the herd. They rarely decide

autarchically, that is without regard to their milieu.
And in herds there are Alpha animals who lead the
herd and provide direction. People like to imitate
the behaviour of successful Alpha animals.

14
 Behavioral finance

Emotion / Affect Your friend has equity portfolio B and

exchanges it for equity fund A. As a result he
Rational decisions are superimposed on emotion receives €10,000.00 less than he could have
and affect. The combination of both sides of the received with equity portfolio B.
brain, the cortex and the limbic system, plays a
particular role here. The most important charac- Who is more annoyed? You or your friend?
teristic is the oscillation between fear and greed,
or put more elegantly: the attempt to prevent Presumably you say your friend is more upset.
losses and obtain rewards.12 He actively decided on the change and as a
result received less profit. Except that in your
Moods are another thing that influence our case it is a matter of lost prospects (“opportunity
investment decisions. Whether we are lucky or costs”); in the case of your friend it is actual losses.
unlucky, nervous or impassive, stressed or relaxed But you both have the same result. Therein lies
they all influence our investment behaviour. Not the difference as to how something is regretted.
forgetting of course stimuli such as coffee, alco-
hol or medication that affect our mood. Social
Happy people for example are more decisive and People are creatures of the herd. They rarely
are rather inclined to an over-estimation of their decide autarchically, that is without regard to
own abilities. They are more willing to take risks their milieu. And in herds there are Alpha animals
and readily ignore even important detailed infor- who lead the herd and provide direction. People
mation. They get over losses easier and try again. like to imitate the behaviour of successful Alpha
People who tend to be depressive are detail-ori- animals.
ented and indecisive. They want to avoid losses if
at all possible. Are you aware of that? Have you ever bought
a “hot tip” that turned out to be a non-starter
Optimistic people consider the risks less than afterwards? There are no such “hot tips”. Hard
­anxious people. work underlies recommendations that promise
success. Why should anyone give away the
Moods themselves can thereby be affected by results of their work? Perhaps he is only doing it
investment performances. The sense of pleasure because he is looking for someone who will buy
from a good investment frequently decreases his tips from him so that he can rake in a profit
the evaluation of the risks, the over-estimation or because he wants to earn the commission.
of one’s own abilities increases and can lead to With all their rational weaknesses people are
additional purchases. A series of successes can nevertheless still economists.
then lead to blind greed that masks all rational
thinking and immunises people against warning So what have you really done with your pur-
information – and that can end up in a fully chase? You have imitated someone, who “must
The majority of peo-
fledged rogue trader. Self-control has become be in the know”. Because he is a broker for exam- ple feel more regret
totally blocked out. ple, or a “proven expert” in internet stocks, or this, from something that
or that, or the other. Or simply an Alpha animal. they have done than
The case with failures is the opposite. This misfor- from something that
they have not done.
tune leads to elimination effects and to aversion. Perhaps you were only caught out because a lot
of others also trusted this tip. It appeared in all
Regret: The majority of people feel more regret the newspapers and spread like an epidemic. An
from something that they have done than from epidemic that with the help of rationality could
something that they have not done. only be managed with great difficulty.

Example: You have an equity portfolio A and Another thing: Do we feel most at home in the
are considering whether they should change it herd because it provides security? Why develop
for equity portfolio B, but then do nothing. In another opinion; the majority must be right,
hindsight you find out that this way they have mustn’t they? If however each person relies only
lost €10,000.00. on the majority, who really decides any more –
and is that rational?

12
c ompare: Kahnemann, Daniel / Knetsch, Jack / Thaler, Richard, 1991, The endowment effect, loss aversion, and status quo
bias, Journal of Economic Perspectives
15
Behavioral finance

Cascading information is not dissimilar in its con- by (rental properties in your street instead of
sequences from herding. It does not, however, real estate investment prospects around the
originate from the deliberate orientation of the world)? Try taking a look beyond your own
herd, rather it is a result of sharing collective infor- backyard.
mation and exchanging it. Research reports,
ticker notices, current prices etc. ... are pieces of – R
 educe the complexity of your decisions so
information that are available to everyone at that you are not too constricted in the way you
the same time. Then investment decisions are view things, but at the same time do not land
nourished from the same sources and are fre- yourself with a jumble of information. Regular
quently evaluated by people who are in contact commitments entered into for the long term
with one another, for example because they are can help: someone who has once decided
present on the same trading floor. Who would be which risk type he or she is for the investment
surprised if they come to the same or at least sim- doesn’t have to constantly determine his or
ilar assessments and decisions? Often it only her shares or borrowings ratio again, and is
takes a rising price in order to produce future also protected from the need to be gazing
­purchases. constantly at the equity price ticker. Once you
have decided which particular investment
Outsmart yourself! themes (emerging countries, new energies,
commodities) you want to add and what
Nobody is free from behaviour-oriented invest- does not fit into your plan doesn’t have to be
ment decisions, the consequence of which constantly thinking about all possible new pro-
is less-than-optimal investments. We are people, posals.
not robots. We are a combination of heart and
brain – and even the brain is not a machine that – C
 omplexity reduction can also mean basi-
only knows one process to the right result. cally only investing in what one has really
understood. What use are the best investment
Because of that, remember, in every (investment-) ideas that promise high returns, but whose
decision: Outsmart yourself! In order to make this risks are not assessable?
easier, here is a checklist that should precede
each decision: – P
 lus: a good basic understanding also helps in
reduction of complexity. For example some-
– A stringent investment process, one that prefer- one who has realised that a higher expected
ably eliminates emotional behaviour, helps rate of return is generally linked to a higher risk
against an over-estimation of one’s own abili- is immune from irresponsible investments
ties. Restricting oneself to an investment uni- which do not pay off in the long run.
verse in which the investor has specific know­
ledge is a first step to self-commitment. Then – T he danger of a lack of basic understanding
fundamental analysis should follow, looking is also that you miss out on good prospects
at future expected income and not at previous because you always postpone the decision
successes. on them – because you don’t have the know­
ledge. Therefore you are investing in your
– F
 ind information which contradicts your opin- ­general financial education.
ion, and have conversations with people who
can assume the role of devil’s advocate. This – T ake stock of your emotional state at the time
protects you against being addicted to self-af- of the upcoming decision: Are you perhaps
firmation. especially strung up on coffee just now, or on
a series of successes in capital investments
– Think of the danger of believing you knew that are making you headstrong? As a basic
If everyone only
everything in advance, even if your memory principle sleep on far-reaching decisions over- thinks the same thing,
suggests this. night. What still seems good in the mor­ning is then not a lot will be
worth a second look. thought about.
– Is the “window”, from which you regard the
investment world large enough for you to – W
 hich emotionally-controlled behavioral
decide between important investment alterna- ­patterns are you potentially subject to? Are
tives, or do you look through a too-small you prone to over-estimate your own a ­ bilities?
“frame” onto the world, because you know Are you affected right now by a particular
something particularly well (“German compa- market phase or by price gains? Have you also
nies”), because you like a particular story considered negative information that does not
(“internet shares”) or something special is close tally with your opinion or do you simply ignore

16
 Behavioral finance

it because it is unpleasant to you, or because – D

 o you only follow the herd because everyone
it does not fit in with your world-view? Do you is talking about certain capital investments, or
prefer to sleep overnight on a decision and / or do have you your own opinion, which fails to
do you look specifically for information that be affected by self-appointed experts with
contradicts your positive view? “hot tips”? Do your own research and look for
other routes.
– W
 hat actually makes you hold onto a security
that produces losses? Is it the purchase price – “What you can do today do not put off until
as reference value or is it the determined tomorrow” is a popular saying full of wisdom,
expectation of future profits, on the basis of giving preference to the here and now at the
which you have recalculated the price that can expense of foresight, and the tendency to stick
be expected? Ask yourself the basic question: with what is familiar.
Would I buy this security again today? If not:
 iscipline is important. Anyone who regularly
– D
– “ Limit losses, let winners go” is for the most examines his financial assets runs less danger
part a good rule against denial of wrong deci- of becoming a victim of ostrich-like behaviour”
sions or the premature realisation of profits when it comes to losses.
which place a quick profit now above even
greater yields in the future. Investors are people too – and as such we
are intelligent enough to recognise that and the-
– Actively managed portfolios can be a good refore capable of conquering our human weak-
tool against loss aversion and a habit of pro- nesses. And that’s why the slogan is:
crastination. Management takes over the pur-
chase and sale of securities. The investor dele- Outsmart yourself!
gates these actions and may be less likely to
remain victim to the tendency to sell losers too Dr Hans-Jörg Naumer
late and profits too early.

Bibliographical references

Gadarowski, Stefan, Financial Press Coverage and Expected Stock Returns,

in: European Financial Management Association, 2002, Presentation.
Hirschleifer, David (2001), “Investor Psychology and Asset Pricing”, Journal of Finance 56
Kahneman, Daniel / Tversky, Amos, Prospect theory: An analysis of decision under risk.
In: Econometrica, Band 47, 1979
Kahneman, Daniel / Tversky, Amos, Rational Choice and the Framing of Decisions,
Journal of Business 59
Kahneman, Daniel / Tversky, Amos. „Judgment under uncertainty: Heuristics and biases“.
Science 185 (4157), 1974
Kahnemann, Daniel / Knetsch, Jack / Thaler, Richard, The endowment effect, loss aversion,
and status quo bias, Journal of Economic Perspectives, 1991
Peterson, Richard L. (2007), “Inside the Investor’s Brain”, New Jersey
Montier, James (2002a), “Part man, part monkey”, Dresdner Kleinwort
Montier, James (2002b), “Behavioral Finance – Insights into Irrational Minds and Markets”,
Chichester
Peterson, Richard, Inside the Investors Brain, New Jersey 2007
Thaler, Richard (Hrsg.): Advances in Behavioral Finance. Band I, Russell Sage Foundation, 1993
Wikipedia.org on: Behavioral Economics and Prospect Theory

17
Behavioral finance

Further Publications

Embracing Disruption Navigating rates

→ Being a rational optimist → Investing in times of inflation

→ Capital Income in times of disruption
Active Management → Helicopter Money

→ Inefficient Markets – a quick literature review

ESG – achieving sustainability

Tactical Asset Allocation → Green growth with #FinanceForFuture

→ #GreenGrowth – The green wave of growth
→ The Week Ahead
→ “Degrowth” or “green growth”? That’s the real question
→ Capital Markets Monthly
→ A “green bubble” or investing in a sustainable future?

Behavioral Finance

→ The 7 habits of successful investors

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