Test yourself for investing overconfidence

Investors with an “overconfidence” bias often trade too much and manage their portfolio on a stock-by-stock basis—while assuming they can beat the market, which the University of Chicago’s Mr. Thaler says probably won’t happen.

Mr. Thaler recommends a little test for the presence of an overconfidence bias. “Write down 10 traits [such as ‘investment skill’ or ‘ability to make good stock picks’], then ask yourself how you rate compared to your co-workers. If you rate yourself above average on all of them, plead guilty,” he says.

From the Wall Street Journal

The hometown bias puzzle in investing

In its chapters on investing, Nudge puzzles over the “home bias puzzle,” in which investors in a given country tend to overweight their portfolios with stocks from that country. So for instance, although U.S. equities make up less than half of the global stock market, most U.S. investors’ portfolios are dominated by them. This kind of geographical proximity in investing is often explained by differences in regulation, culture, and taxation between nations, as well as differences in understanding about home versus foreign companies. These frictions can occur within nations as well, according to Tobias Moscowitz (of Chicago’s Booth School of Business) and Joshua D. Coval, leading to what might be called the “hometown bias puzzle.”

Using a unique database of mutual fund managers and company locations, identified by latitude and longitude, we find that the average U.S. fund manager invests in companies that are between 160 to 184 kilometers, or 9 to 11 percent, closer to her than the average firm she could have held. Alternatively, one out of every ten companies in a fund manager’s portfolio is chosen because it is located in the same city as the manager. With a variety of measures used, the null hypothesis of no local equity preference (or local bias) is consistently rejected, demonstrating that the distance between investors and potential investments is a key determinant of U.S. investment manager portfolio choice.

Why the hometown bias? Familiarity and understanding.

We find that local equity preference is strongly related to three firm characteristics: firm size, leverage, and output tradability. Specifically, locally held firms tend to be small, highly-levered, and produce goods not traded internationally. These results suggest an information-based explanation for local equity preference, since small, highly levered firms, whose products are primarily consumed locally, are exactly those firms where one would expect local investors to have easier access to information and are firms in which such information would be most valuable.

A pdf of the working paper is here.

A commitment strategy for when the stock market is in free fall

Don’t check your 401(k) portfolio on a week like the last one, especially if you’re young. Take a tip from this guy.

Scott Jaffa, a 25-year-old systems administrator in Silver Spring, Md., called yesterday’s plunge “as much a test of my psychology as anything else.” Because he does not need the money “for another 30 to 40 years,” he asked rhetorically, “why should I worry myself about its performance over a period of days or weeks or even months?”

Mr. Jaffa is already developing what the ancient Stoics and the great Danish philosopher Søren Kierkegaard called ataraxia, or imperturbability. But he knows that ataraxia does not come naturally; it takes work. A year and a half ago, Mr. Jaffa destroyed the online access code for his 401(k) so he could no longer have instant access to his retirement accounts. His goal was to make it “significantly harder” and to require “human interaction” before he could trade on his own emotions. That enabled him to watch Monday’s decline without acting on it.

From the Wall Street Journal.

Investing humor

The Behavior Gap keeps a log of amusing quotes about our financial frailty including this one from author Jonathan Clements: ““If you want to see the greatest threat to your financial future, go home and take a look in the mirror.”

There are also a few Indexed-esque venn diagrams like this one about when you know if your stock picks are likely to bomb.

To: Investors – Re: Company annual reports

What do you do with company annual reports?

If you own stock, you have probably received an annual report or two from your broker in the past month (it comes in the dark blue plastic bag with that board of directors ballot you probably never fill out). If you own a lot of stock – Forbes 400-style – you’ve probably gotten a small forest worth of annual reports (and you probably do fill out that ballot for a few companies). The default rule at most brokers is to send an annual report by mail, but this seems like a policy that might be ripe for change.

Continue reading the post here.