Investing and throwing darts share many similarities.
Most investors and dartists miss. But simple behavioral nudges can help improve our accuracy so that we're more on target.
Take Richard H. Thaler's often-cited example of the urinals at an Amsterdam airport: Patrons were making a mess. Their aim was off. Why? Maybe they were distracted, tired, or simply careless. They weren't irretrievably confused or directionally challenged, but their failures were embarrassing — and easily corrected.
As Thaler recounted, an economist developed a simple fix: etching a small black fly into each urinal. Now that patrons had something to aim at, "spillage" decreased by 80%. Thaler’s book, Nudge, which he co-wrote with Cass Sunstein, discusses these types of behavioral conundrums with insights on how seemingly irrelevant details influence and alter everything we do.
Thaler reviewed many of our behavioral frailties during his lively and engaging presentation at the 70th CFA Institute Annual Conference in Philadelphia. The key takeaway: If only we could learn.
Thaler reminded the audience how counterproductive we can become in everything we do. Our innate irrationality coupled with a lack of adequate expertise lead to subpar, amateurish outcomes. Yet we remain overconfident in our abilities, with often unpleasant results: From choosing the wrong career to failing to save for retirement, our choice pathways remain strewn with predictable errors.
The Fallacy of Intervention
Some of these errors, Thaler noted, like the decision to intervene, are pervasive and stand out for their disappointing outcomes. When things are going badly, we feel an irresistible urge to step in. The logic, on its face, is flawless. Things are not working right, so it's time for us to make changes.
But we forget how we tend to misconstrue causality, misunderstand our competence, and implement changes that, more often than not, lead to failure.
The illusions of skill and validity and a web of other biases muddle our judgment.
Active fund management offers important insights on interventions. Understandably, active management has faced a difficult time in recent years. Hedge fund attrition is increasing. More than 10% of hedge funds close every year. Investors' innate bias towards discarding underperformers makes the difficult job of active investing all but impossible.
Thaler's presentation offered evidence on how ad hoc hiring and firing based on performance lead to poor outcomes. Thaler's advice? Use processes and well-deliberated algorithms to handle successes and failures.
Behavioral finance makes it clear that human activity, by its nature, is permanently constrained in its ability to optimize decisions. We are not maximizers. We need help, especially with complex choices and in endeavors that require us to exercise control over our biases. Without access to expert thinking, our mistakes will recur. Our record of overcoming behavioral challenges is weak.
So correcting for irrationalities is the wrong approach.
What does Thaler recommend investment decision makers do instead? Generate returns by building a better understanding of the biases and tendencies of everyone involved.
Professor of behavioral science and economics at the Booth School of Business, University of Chicago
70th CFA Institute Annual Conference
Philadelphia, Pennsylvania
21 May 2017
This session from the 2017 CFA Institute Annual Conference discusses: Assumptions of economics — the plausibility of optimization, self-interest, and self-control; the “magic market” and how it should work — considering the efficient market hypothesis, right prices, and rational markets; and behavioral economics and management — sunk costs, framing, default options, mental accounts, and the fallacy of intervention.
JOHN L. BOWMAN, CFA: Good afternoon, everyone. Welcome to Philadelphia and the 70th CFA Institute Annual Conference. We’re excited to share the next three days and hope that you’ll come away with new insights, new colleagues, and be inspired to sharpen your investment edge.
I’m John Bowman, managing director of the Americas for CFA Institute. And I’m pleased to be serving as your master of ceremonies over the next few days. We’re glad that you’ve joined us, whether this is your first time at the Annual or whether you’re a regular.
This year, our in-person audience totals more than 1,800 delegates, attendees from more than 75 different countries. As you might expect, the US has the highest number of delegates. Canada, Canada comes in second.
[APPLAUSE]
Also not surprising. But third, the bronze medal might be a surprise, although they claim it every year, and that is South Africa.
[APPLAUSE]
And I’m told, Canadians, that they are only seven delegates behind, so I would watch your back carefully. In addition to our in-person audience this year, we have launched Virtual Link, an online conference experience. And we welcome those members and industry professionals who are joining us remotely right now. Virtual Link will bring the Annual Conference to our broader global membership with live broadcast of select sessions like this one, exclusive speaker interviews, and discussions on current topics.
We started broadcasting live this afternoon, and we’ll continue with programming until Wednesday. All Virtual Link content will be archived for on-demand viewing, so please, share with your colleagues.
To help you navigate the conference over the next few days, you each have a pocket guide tucked behind your badge. We also have a fantastic Annual Conference app that allows you to build your own schedules, search for and message other delegates, and access speaker presentations. So, if you haven’t already downloaded that app, please do so tonight. And if you need any help, please see the registration desk.
And one of the benefits of the conference is meeting and talking with new colleagues from around the world. In order to locate fellow conference goers with common areas of focus, be sure to update your profile in the app and affix the stickers that you received at registration to your name badge.
As we go through the next three days of thought-provoking sessions, unique experiences, and professional insights, be sure to share your perspectives with your networks and your global investment community. Please remember to use #CFAedge on Twitter and in all social media activity. You can follow the blog through either the app or online. In past years, we’ve been a trending topic, so the pressure’s on again here in Philadelphia. So, we can’t wait to see what your social media posts bring this year.
Now for me, taking the stage here this evening represents a personal journey that has come full circle, because it was right here in Philadelphia in 2005 that I attended my first Annual Conference. And so, I’m thrilled and humbled to be a small part of this great event.
But the larger narrative, of course, around this great city is that CFA Society of Philadelphia was one of the five founding societies, preceding even CFA Institute itself, that had the vision for a federation of societies that would work collaboratively to build a trustworthy and sustainable investment management profession. And 70 years later, the society continues to lead from the front.
We’d like to express our gratitude for the help and the support of our colleagues at CFA Society of Philadelphia throughout the last year. The contributions of society leaders are critical to all that we do at CFA Institute, but that is particularly true when planning the annual conference. So, here to welcome you on behalf of CFA Society Philadelphia is Society President Peter Maher, CFA. Along with several other Society leaders, Pete has played a pivotal role in the planning of this year’s conference. Pete.
[MUSIC PLAYING]
PETER MAHER, CFA: Thanks, John. Well, we are finally here. Welcome to Philadelphia. Benjamin Franklin once said, “An investment in knowledge always pays the best interest.” So, it is in that spirit that we welcome our members and guests attendees, our conference presenters, and our panelists, and CFA Institute staff. Thank you for choosing to expand your learning for the next three days here with us in the birthplace of American democracy.
That many of you have traveled such long distances to be with us serves to remind us just how important the Annual Conference has become. As president of CFA Society Philadelphia, I’ve been fortunate to lead an organization with a long history of professional excellence.
Founded in 1943, the CFA Society of Philadelphia was a founding member of the National Federation of Financial Analysts Societies, the organization that would evolve into CFA Institute. Today, with over 2,100 members, CFA Society Philadelphia has had much success in the areas of financial literacy, university outreach, and most recently, with our work in the area of women and investing.
The city of Philadelphia is generally recognized as the place where revolutionaries asserted their independence and later framed the new nation’s government. Yet little is spoken of the role the city and its prominent sons played in shaping the very infrastructure of our country’s financial markets and institutions.
Today, New York is known as our financial capital. However, before Wall Street, there was Chestnut Street. Before the Federal Reserve was created, there was the First and then the Second Banks in the United States. All three landmarks you see here are just a short walk from where you’re sitting.
It can be said that Philadelphia parented our nation’s financial system, with notable citizens playing leading roles along the way. Before there was a Rockefeller or a Carnegie, there was Stephen Girard, a Philadelphian, a banker, and a philanthropist. Girard personally saved the US government from financial collapse in the early years of the 19th century. There was Jay Cooke, innovative investment banker, credited with creating a model for the wire house, and also developing new techniques in securities issuance.
And there was Anthony Drexel, renowned banker and Philadelphian who was asked to mentor the troubled son of a New York business partner. Drexel would then go on to start a partnership with that young man and create a firm that would pioneer investment banking and practice, financing America’s railroad system, deepening the capital markets, and stabilizing markets in times of panic. The name of Drexel’s protégé — JP Morgan.
And there’s no better known Philadelphian than Benjamin Franklin. Among his countless achievements, Franklin founded and was the first president of the Academy and College of Philadelphia. That institution would later come to be known as the University of Pennsylvania, giving birth to the Wharton School of Business.
And once again, Franklin implores the individual to further his or her learning when he said, “If a man empties his purse into his head, no man can take it away from him.” Wise words indeed. So it is our hope that you enjoy the conference and be taken with our city. CFA Society Philadelphia is determined to help you make the most of your investment. Thank you.
[APPLAUSE]
JOHN L. BOWMAN, CFA: Thanks so much, Pete. Yeah.
PETER MAHER, CFA: Appreciate it.
JOHN L. BOWMAN, CFA: All right. Thank you, Pete. And it’s never good form to correct your host so early in the program, but you forgot a critical piece of the legacy of this great city. And that, of course, for those of us particularly, the Americans in the room, is that it was the birthplace of the demise of none other than Apollo Creed, Clubber Lang, and of course, Ivan Drago. So maybe he’ll review that in the follow-up.
Now before we begin the session, we’d also like to recognize our two platinum sponsors for the conference, Macquarie Investment Management and Vanguard. Their generous support helps us to produce this amazing event.
As we begin our opening session, let me remind you to use the cards provided to submit your questions for the speaker, and pass it to one of the volunteers that will be circling the room. At the end of the session, the moderator will pose the questions to the speaker, as time permits.
At this time, I’m pleased to introduce Marg Franklin, who will moderate our keynote session this evening. Marg is president of BNY Mellon Wealth Management Canada and has served in senior positions at Marret Private Wealth, Barclays Global Investors, State Street Global Advisors, and Mercer. Marg is a former chair of the CFA Institute Board of Governors, one I had the benefit and great pleasure of serving under, a past president of CFA Society Toronto, and is currently part of the leadership team for the Women in Investment Management Initiative, including the Alpha and Gender Diversity conference. Please welcome Marg Franklin.
[MUSIC PLAYING]
MARG FRANKLIN, CFA: Thank you.
[LAUGH]
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Photo courtesy of W. Scott Mitchell
Transcript
BEHAVIORAL ECONOMICS: PAST, PRESENT, FUTURE, AND FOOTBALL
RICHARD H. THALER
View the full transcript (PDF).
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1 Comment
tells us nothing in way of better investing. solutions . fun but of little practical use