Document 6517843

“Inevitably, [investors]
lose out on a better
opportunity while
waiting for ‘their’
stock to fight back.”
Leading Wealth Advisor
Nancy E. Cooley, Senior Vice President and Financial Advisor
Falisha I. Mamdani, Senior Vice President and Financial Advisor
Jason M. Friedman, Vice President and Financial Advisor
You may remember Eugene Fama
from Econ 101. He argued that in
an efficient market that includes
equally well-informed and rational
investors, securities will be appropriately priced to reflect all available
data1. The rejection of the theory is
represented by another breed of market analyst who believes markets are
inherently inefficient, and prices are
not always an accurate reflection of
the intrinsic value of securities.
Enter behavioral finance, which
seeks to understand how investor
psychology influences decisions
and which might better explain
anomalies like bubbles and crashes.
A common bias that affects
even the most seasoned investor
is anchoring2, or placing too much
emphasis on one factor or trait when
making a decision. Loss aversion 3
is a typical example of anchoring;
investors get anchored to their cost
basis and are so intent on breaking
even, they lose focus on whether the
security is still a good long-term
investment. Inevitably, they lose out
on a better opportunity while waiting for “their” stock to fight back.
”
Confirmation bias, or seeking
out information that supports one’s
own view, undermines the rational
decision-making process. In this
scenario, bullish investors seek out
positive data points, whereas bearish investors find negative data
points. 4 Similar to confirmation
bias is herding behavior, which is
most often characterized as both
irrational and driven by emotion.
Periods of panic buying or selling
are examples of extreme market
sentiment in which there is a clear
disconnect between prices and fundamentals. These are, in our opinion, the critical times for investors
to recognize the psychology of the
markets and to avoid the pitfalls of
emotional decision making.
The “recency effect”5 refers to
investors placing greater relative
importance on events that have
occurred in the recent past. In our
view, the crash of 2008 has spawned
a cottage industry of bubble hunting
even though a repeat of a wholesale
market drawdown of a similar magnitude is unlikely, statistically speaking. Linked to this bias is herding
behavior,6 for example, investors who
overreact and shift completely out of
an asset class, i.e., equities, to protect
against a disastrous loss instead of
looking at the potentially greater risk
of inflation. This leads investors to
irrationally prepare for a devastating
event with a 5 percent probability
of occurring and to ignore the more
mundane 50 percent event.
Lastly, we draw attention to the
concept of money illusion. 7. For
example, let us say an avid movie fan
invested in a bond 10 years ago that
pays $5 interest per year to purchase
one ticket. Fast forward 10 years.
Our fan is stuck watching matinees
because his $5 interest payment no
longer covers a primetime movie. He
did not lose any money, but in real
terms he lost purchasing power.
The CMF Group continues to
stress the importance of taking in
all available information when making decisions and structuring tactical portfolios with as little emotional
overlay as possible. We believe this is
the best way to avoid the biases that
can stand in the way of prudent and
thoughtful active management.
http://www.dimensional.com/famafrench/2009/08/fama-market-efficiency-in-a-volatile-market.html, Journal of Finance, May 1970: Efficient Capital
Markets: A Review of Theory and Empirical Work; 2 Tversky, A. & Kahneman, D. (1974), Judgment under uncertainty: Heuristics and biases. Science, 185,
1124-1130; 3 Kahneman, D., Knetsch, J., & Thaler, R. (1990), Experimental Test of the Endowment Effect and the Coase Theorem, Journal of Political Economy
98(6), 1325-1348; 4 Zweig, Jason (November 19, 2009), How to Ignore the Yes Man in Your Head, Wall Street Journal (Dow Jones & Company), http://online.
wsj.com/article/SB10001424052748703811604574533680037778184.html, retrieved 2010-06-13; 5 Murdock, B.B., Jr. (1962) The Serial Position Effect of Free
Recall, Journal of Experimental Psychology, 64, 482-488; 6 Markus K. Brunnermeier, Asset Pricing under Asymmetric Information: Bubbles, Crashes, Technical Analysis, and Herding, Oxford University Press (2001); 7 John Maynard Keynes, Fisher, Irving (1928), The Money Illusion, New York: Adelphi Company. Tax laws are complex and subject to change. Morgan Stanley Smith Barney LLC, its affiliates and Morgan Stanley Smith Barney financial advisors
do not provide tax or legal advice. This material was not intended or written to be used for the purpose of avoiding tax penalties that may be imposed on the
taxpayer. Individuals are urged to consult their personal tax or legal advisors to understand the tax and related consequences of any actions or investments
described herein. The views expressed herein are those of the author and do not necessarily reflect the views of Morgan Stanley Smith Barney or its affiliates.
All opinions are subject to change without notice. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or
sale of any security. Past performance is no guarantee of future results. © 2011 Morgan Stanley Smith Barney LLC, member SIPC.
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– The CMF Group
The CMF Group at Morgan Stanley Smith Barney
By The CMF Group at Morgan Stanley Smith Barney
Reach Nancy at 212.315.6228, Falisha at 212.315.6253, or Jason at
212.307.2853. We look forward to serving as a resource for you.
live
“
What is behavioral finance,
and should it matter to me?
How to reach The CMF Group
grow
The CMF Group at Morgan Stanley Smith Barney
make
New York, NY
Left to right: Jason M. Friedman,
Nancy E. Cooley and Falisha I. Mamdani
About The CMF Group
Nancy E. Cooley, Falisha I. Mamdani and Jason M. Friedman, of The CMF Group, are advisors within
Morgan Stanley’s Private Wealth Management Division. With 57 years of combined industry experience,
they provide customized wealth management solutions for individuals, families and institutions. Ms.
Cooley, a senior vice president and a senior investment management consultant, has been named among
Barron’s top 100 women financial advisors since 2006. A native of the San Francisco area, she graduated
from UC Berkeley. Ms. Mamdani, a senior vice president and a senior investment management consultant,
was one of Barron’s top 100 women financial advisors in 2006 and 2009. Born in Tanzania and raised
in Bahrain, she graduated from Sevenoaks School in the United Kingdom and Brown University. Mr. Friedman
is a vice president and an investment management consultant. A native of Long Island, N.Y., he is a graduate
of the University of Maryland and has an MBA degree from the Stern School of Business at NYU. Assets Under Management
$800 million (as of 1/2011)
Compensation Method
Asset-based fees and commissions (insurance products)
Minimum Net Worth Requirement
$5 million
Primary Custodian for Investor Assets
Morgan Stanley Smith Barney
Largest Client Net Worth
Confidential (available on request)
Professional Services Provided
Planning, investment advisory and money management services
Financial Services Experience
Cooley, 29 years; Mamdani, 20
years; Friedman, 8 years
Email nancy.cooley@morganstanleypwm.com
falisha.mamdani@morganstanleypwm.com
jason.friedman@morganstanleypwm.com
The CMF Group at Morgan Stanley Smith Barney
590 Madison Avenue, 11th Floor, New York, NY 10022
worth.com
212.315.6228
october-november 2011
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