John R. Nofsinger > Quotes

“Mental shortcuts, also called heuristic simplifications, help us analyze situations and make decisions quickly in our daily life. However, this process often leads us astray when analyzing decisions with risk and uncertainty. Because investing decisions involve substantial risk and uncertainty, our decisions are biased in predictable ways. The representativeness bias causes us to extrapolate the past and assume that good companies are good investments. The familiarity bias causes us to believe that firms we are familiar with are better investments than unfamiliar firms. Thus, we own more local firms and our employer’s stock and few international stocks. Thus, these biases lead to low diversification and higher risks.”
― John R Nofsinger, The Psychology of Investing

“The DRD4 gene has variations called alleles that differ in the number of times a segment of the gene repeats itself. The most common versions are either the 4-repeat allele, which is carried by approximately three-quarters of the population, or the 7-repeat (or more) allele. The presence of the higher-repeating alleles (7 or more) has been shown to be related to reduced sensitivity to dopamine. A reduced sensitivity to dopamine requires relatively more stimulation to provoke the same internal reward. People with at least one allele of 7-repeats or longer are more likely to engage in novelty-seeking or compulsive gambling.”
― John R Nofsinger, The Psychology of Investing

“A common adage on Wall Street is that the markets are motivated by two emotions: fear and greed. Indeed, this book suggests that investors are affected by these emotions. However, acting on these emotions is rarely the wise move. The decision that benefits investors over the long term is usually made in the absence of strong emotions.”
― John R Nofsinger, The Psychology of Investing

“stocks that have done great for the past three to five years are considered winners. Investors assume this past return is representative of what they can expect in the future. Investors like to chase winners and buy stocks of firms that have trended upward in price.5 However, losers tend to outperform winners over the next three years by 30 percent.6 Mutual fund investors also use this same extrapolating heuristic. The mutual funds listed in magazines and newspapers with the highest recent performance receive a flood of new investors. These investors are chasing the winners. Indeed, a study of investor mutual fund trades finds that the investors who follow mutual fund trends are investors who exhibit other behavioral biases in their investment activities.7 As this is not an optimal strategy, the return chasing money is often referred to as “dumb money.”
― John R Nofsinger, The Psychology of Investing

“Employees who work for a company whose stock price increase ranked among the top 20 percent of all firms in the past five years allocated 31 percent of their contributions to the company stock. This compares to an allocation of only 13 percent to company stock in firms whose performance was in the worst 20 percent. The actual 401(k) asset allocation behavior of employees suggests that they use the past price trend (the representativeness bias) as a determinant for investing in the company stock (the familiarity bias).”
― John R Nofsinger, The Psychology of Investing

“Therefore, in the long run, national stock markets with lower home bias should have lower returns. In each of 38 countries, the second study computes a measure of home bias and compares it to the country’s MSCI index return.21 Figure 8.5 shows a scatter plot of home bias versus annual market return (during the period 1998 to 2007) for the 38 countries. Note the clear trend of higher home bias being associated with higher domestic market return. This creates a high cost of capital for the firm in countries with high degrees of home bias.”
― John R Nofsinger, The Psychology of Investing

“High suicide rates in one month are associated with poor stock returns during the same month and during the subsequent month. Again, negative emotions are associated with poor stock market returns.”
― John R Nofsinger, The Psychology of Investing

“The theory postulates that for opposite-sex fraternal twins, the higher level of prenatal testosterone in the amniotic fluid from the male fetus increases the pre-birth testosterone exposure of the female fetus. This results in a masculinization of the female twin. In general, women tend to be more risk averse than men. If this transfer theory and prenatal testosterone exposure theory are correct, then the female twin of a female-male pair should take more financial risk than other women, all else equal.”
― John R Nofsinger, The Psychology of Investing

“The portfolios of overconfident investors will have higher risk for two reasons. First is the tendency to purchase higher-risk stocks. Higher-risk stocks are generally from smaller, newer companies. The second reason is a tendency to underdiversify their portfolios. Prevalent risk can be measured in several ways: portfolio volatility, beta, and the size of the firms in the portfolio. Portfolio volatility measures the degree of ups and downs the portfolio experiences. High-volatility portfolios exhibit dramatic swings in price and are indicative of underdiversification. Beta is a variable commonly used in the investment industry to measure the riskiness of a security. It measures the degree a portfolio changes with the stock market. A beta of 1 indicates that the portfolio closely follows the market. A higher beta indicates that the security has higher risk and will exhibit more volatility than the stock market in general.”
― John R Nofsinger, The Psychology of Investing

“Antonio Damasio reported on patients who suffered damage to the ventromedial frontal cortices of the brain. This damage leaves intelligence, memory, and capacity for logic intact but impairs the ability to feel. Through various experiments, it was surmised that the lack of emotion in the decision-making process destroyed the ability to make rational decisions.3 Indeed, these people became socially dysfunctional. Damasio concluded that emotion is an integral component of making reasonable decisions.”
― John R Nofsinger, The Psychology of Investing

“The tools of traditional finance, like modern portfolio theory, can help investors establish efficient portfolios to maximize their wealth with acceptable levels of risk. However, mental accounting makes it difficult to implement these tools. Instead, investors use mental accounting to match different investing goals to different asset allocations. This often leads to investors diversifying their portfolios by goal rather than in total. When investors pick investments in each goal-focused mini portfolio, they examine each choice’s individual risk and return characteristics and ignore their diversification characteristics. They eliminate the choices they view as inferior and then often simply divide their money equally among the acceptable choices.”
― John R Nofsinger, The Psychology of Investing

“The study findings show that genetics has a similar role in acquiring financial wealth, explaining about one-third of the decisions, as found in the twin studies. The role of genetics is very high (over 50 percent) in educational level attained, but plays no role in the equity portion of the portfolio. The genetic role for stock market participation is nearly 14 percent. Overall, the study illustrates that a person’s genes has an impact on their financial decisions.”
― John R Nofsinger, The Psychology of Investing

“When you are familiar with something, you have a distorted perception of it. Fans of a sports team think their team has a higher chance of winning than nonfans of the team. Likewise, investors look favorably on investments they are familiar with, believing they will deliver higher returns and have less risk than unfamiliar investments. For example, Americans believe the U.S. stock market will perform better than the German stock market; meanwhile, Germans believe their stock market will perform better.26 Similarly, employees believe the stock of their employer is a safer investment than a diversified stock portfolio.27”
― John R Nofsinger, The Psychology of Investing

“Three scholars illustrate the role of intelligence in a data set of Finnish investors in which they have IQ information from prior (mandatory) military service.8 They find that the high IQ investors’ portfolios outperform the low IQ investors by 4.9 percent per year. This higher return stems from the higher IQ investors exhibiting better market timing and stock picking. In addition, they are less prone to the disposition effect and the sentiment of other investors.”
― John R Nofsinger, The Psychology of Investing

“Scholar Diego García examines the tone of the words in two financial news columns of the New York Times over a century.22 He shows that when the fraction of the words in the articles is more negative, the stock market declines the following day. That is, negative sentiment leads to lower stock prices. The market reaches the bottom when sentiment is very pessimistic, thus leading to long-term higher returns.”
― John R Nofsinger, The Psychology of Investing

“the day after the season finale, the stock market declines.14 People are sad about the end of their show—it is the end of a relationship people experience with the characters of the show. If enough people experience these negative emotions, the misattribution bias can impact the stock market.”
― John R Nofsinger, The Psychology of Investing

“Optimism skews a person’s beliefs and judgments. Optimistic people believe they are less likely than average to experience disease and divorce or to be a victim of crime. This belief can cause the optimist to take unnecessary risks.”
― John R Nofsinger, The Psychology of Investing

“The outcome of soccer matches in the European or World Cups produce substantial mood swings in a large proportion of a country’s population. Psychologists have found an increase in heart attacks, crimes, and suicides accompanying sporting losses.”
― John R Nofsinger, The Psychology of Investing

“When individual investors are optimistic, the demand for these funds increases and the discount declines. Pessimistic investors sell the funds, and the discount increases.”
― John R Nofsinger, The Psychology of Investing

“People can be overconfident. Psychologists have determined that overconfidence causes people to overestimate their knowledge, underestimate risks, and exaggerate their ability to control events.”
― John R Nofsinger, The Psychology of Investing

“One financial study examined the types of information, experience, and portfolio returns of investors.14 The study confirmed that lower returns occur for less-experienced investors when they rely more on unfiltered information. Relying on filtered information improved returns for these investors. More experienced investors can achieve higher returns using unfiltered information. Presumably, experience helps them turn knowledge into wisdom.”
― John R Nofsinger, The Psychology of Investing

“Can Money Make You Happy? Can money make you happy? Of course it can! But does it? You can use behavioral finance concepts to spend your money in ways that increase your happiness. Here are four ways to spend your way to happiness:9 (1) Buy experiences, not things. (2) Buy many small things instead of few big ones. (3) Pay now to consume later. (4) Help others.”
― John R Nofsinger, The Psychology of Investing

“the 7-repeat allele are less likely to make the safe, patient financial choice. The neurobiological difference between the groups is that 7-repeat people need more stimulation to feel the same pleasure of dopamine. Small changes in stimulation do not generate enough joy to notice. Small stimuli have little or no effect on 7-repeat people and they seek strong stimuli to feel the dopamine reward. This appears to have an impact on their financial decision making.”
― John R Nofsinger, The Psychology of Investing

“Clifton Green and Russell Jame examine the fluency of corporate names in the United States.23 They measure the ease of pronouncing a company name through its Englishness and whether the words are found in a spell-check filter. The more fluent the name, the more familiar it will seem to a potential investor. They find that firms with more fluent names have higher breadth of ownership, greater trading volume, and higher valuation ratios. This shows that investors favor firms that seem more familiar because they have more fluent names. The authors also report that firms that change names to a more fluent one increase ownership, volume, and valuation. Lastly,”
― John R Nofsinger, The Psychology of Investing

“Another important psychological factor is the illusion of control. People often believe they have influence over the outcome of uncontrollable events. The key attributes that foster the illusion of control are choice, outcome sequence, task familiarity, information, and active involvement.18 Online investors routinely experience these attributes.”
― John R Nofsinger, The Psychology of Investing

“One of these genes, known as DRD4, produces receptors in the limbic system, the prefrontal cortex, and the striatum areas of the brain. These regions of the brain are responsible for motivation, cognition, and emotion. Thus, variations in this DRD4 gene can impact how people are rewarded (with joy) for various thoughts and activities. If these thoughts and activities are about risk and uncertainty, it could impact a person’s level of risk aversion.”
― John R Nofsinger, The Psychology of Investing

“familiarity bias seems to impact returns, risks, ownership, and valuations in the stock market.”
― John R Nofsinger, The Psychology of Investing

“The prospects of large, well-established firms have less uncertainty, so their stocks prices are generally more reflective of actual prospects than of optimistic prospects. For example, the business potential of General Electric, Procter & Gamble, and Intel are well known and leave little room for a high degree of optimism and pessimism. For firms with a high degree of uncertainty, optimists tend to set the stock price until that uncertainty is resolved. This resolution usually includes a downward revision of optimism and a decline in the stock price.”
― John R Nofsinger, The Psychology of Investing

“when the weather is sunny, institutions have a greater propensity to buy stock.”
― John R Nofsinger, The Psychology of Investing

“The brain often uses the familiarity shortcut to evaluate investments. This can cause people to invest too much money in the stocks that are most familiar to them, like their employer’s stock. Ultimately, this leads to a lack of diversification. In summary, investors allocate too much of their wealth to their employer, local companies, and domestic stocks.”
― John R Nofsinger, The Psychology of Investing