ETF UNIVERSITY

Fixing Your
Clients Behavior
The Biggest
Problem Never
Solved
Why investors fear the
wrong things, and what
you can do about it

BARRY RITHOLTZ

Chairman & Chief Investment Ocer

Ritholtz Wealth Management

TODAYS DISCUSSION

What do we fear and why?

How do our fears impact performance
as asset managers and duciaries?

Context helps manage fear

PART I: WHAT DO WE FEAR AND WHY?

WE ARE ALL GOING TO DIE !

Shark: A perfectly evolved killing machine, immortalized in Spielbergs

1975 film, Jaws.

SOMETIMES BY SELFIE

2015 Sele Deaths
1 Fell o a cli S.Africa.
2. Live hand grenade (2)
4. Oncoming train (3)
7. Electrocuted (2)
9. Shot in head w/gun
10. Fell from bridge
11. Fatally shot himself
12. Fell down Taj Mahal
steps

SOMETIMES BY CONE SNAIL

Average Annual American
Animal Deaths
Deer: 120
Bees: 58
Dog: 28
Cow: 20
Horse: 20
Spider: 7
Bear: 1
Alligator: 1
Cone Snail: 1
Lion: 1
Shark: 1

DEADLIEST ANIMAL IN THE WORLD

Mosquitoes are the deadliest creature on

earth; (Human are only second)
Source: Gates FoundaZon, CDC

HUMAN WEEK ON THE SHARK CHANNEL

RISK OF TERRORISM

2010: U.S.
noncombatant fataliZes
from terrorism
worldwide = 25

2011: Terror deaths = 8

Annual deaths due to
struck by lightning = 29 .

Source: CDC, Mueller & Stewart, Terror, Security, and Money.

YOUR ACTUAL RISK

You are
35,079 times more likely to die of heart disease
33,842 times more likely to die of cancer
than a terror attack.

Source: CDC

CAREFUL ROLLING OVER . . .

Sources: NIH, CDC, NOAA, Security Data

FEAR OF FLYING?
Fear, EmoZonal
decision-making
=
Bad judgment
Bad outcomes

Max Planck Institute

(Berlin)

WHAT KILLED AMERICANS 1900 VS 2010

Source: LA Times

WHAT ARE WE AFRAID OF IN MARKETS?

CRASH! HYPERINFLATION! DOLLAR COLLAPSE!

Market Crashes

HyperInaZon

Collapse of the
Dollar

Looking foolish

S&P 500 SIGNIFICANT DECLINES

CATASTROPHIZING MARKETS
Faber on HyperinaZon: Not A Maier Of If But When Business Insider, 9/23/2010

'The Bear Market Is StarZng' Marc Faber CNBC, August 3, 2011

Faber: The Dollar's Value In The Future Will Be Zero Business Insider, 4/18/ 2011

Marc Faber: We Could Experience A 1987-Style Crash This Year Business Insider,
5/10/2012

Marc Faber: Look out! A 1987-style crash is coming. CNBC, August 8, 2013

2014 crash will be worse than 1987's Marc Faber CNBC, April 10, 2014

Dr. Doom calls bubble, adding to gloomy calls CNBC, Nov 2, 2015

Asset Markets Will Crash Like Titanic -Bloomberg, January 6, 2016

REPEATEDLY FORECASTING THE NEXT CRASH

GEORGE SOROS BUYING PUTS

CATASTROPHIZING CENTRAL BANKERS

Economist, Feb 20th 2016

Global Central Banks Are Running Out of Ammo

(CNN/Money February 9, 2016)

Rate-Hikers At the Fed Are Running Out of Ammo
(CNBC May 13, 2015)

Fed Has No Ammo Let (USA Today March 2014)

Federal Reserve: What Happens When The Fed Really
Does Run Out of Ammo? (Time February 27, 2013)

Fed Running Out of Ammo (PoliZco July 31, 2012)

Fed Out of Ammo For Economy (WaPo 8/26/ 2011)

Fed Running Low on Ammo (WSJ August 26, 2010)

Fed Running Low on Ammo (Reuters August 18, 2009)

PART II: HOW DO OUR FEARS IMPACT

OUR PERFORMANCE?

HOW YOUR BRAIN INTERFERES WITH

YOUR INVESTING
Behavioral Economics NeuroFinance Risk Management
1. Herding, Groupthink
2. OpZmism Bias

1. AnZcipaZon vs. Rewards

1. Misunderstanding risk

2. SelecZve PercepZon/RetenZon

2. The purpose of fear

3. ConrmaZon Bias

3. Words vs Images

3. Black Swans

4. Expert Opinions

4. Paiern RecogniZon

4. EvoluZonary baggage

5. Recency Eect

5. Data vs NarraZve

5. Biggest Financial Fears

6. Endowment Eect
7. Hindsight Bias

6. CogniZve Dissonance

6. OvercompensaZon

7. Species of Dopamine Addicts

7. What hurts performance

THIS IS YOUR BRAIN

THIS IS YOUR BRAIN ON STOCKS

OFF-LABEL USE

sildeenal

anZhistamine diphenhydramine.

RISK AVERSION: PLEASURE VS. PAIN

EARTHQUAKE INSURANCE

INVESTOR PERFORMANCE (10 YEARS)

INVESTOR PERFORMANCE (20 YEARS)

POLITICS AND INVESTING DONT MIX

2003: POLITICS AND ASSET MANAGEMENT DONT MIX

2003: POLITICS AND ASSET MANAGEMENT DONT MIX

2003 Tax Cuts > $1 Trillion
Up over 90% over 4 years

2009: POLITICAL INVESTING

Obama is a Socialist! Stay Out of Markets!

2009: POLITICS AND ASSET MANAGEMENT DONT MIX

FASB 157, ZIRP, QE +VERY Oversold Markets
Up 293% over 93 months

PART III: MANAGING OUR FEARS

THOUGH DATA

DEFINING INVESTMENT RISK

The probability that actual
returns on an investment
will be lower than the
expected returns.

FEAR OF DEADLY VIRUSES

RUNAWAY !

CRIME WAVE!

CRIME: THE TREND IS YOUR FRIEND!

-60%

-70%

-80%

-90%
Jan-26
May-28
Sep-30
Jan-33
May-35
Sep-37
Jan-40
May-42
Sep-44
Jan-47
May-49
Sep-51
Jan-54
May-56
Sep-58
Jan-61
May-63
Sep-65
Jan-68
May-70
Sep-72
Jan-75
May-77
Sep-79
Jan-82
May-84
Sep-86
Jan-89
May-91
Sep-93
Jan-96
May-98
Sep-00
Jan-03
May-05
Sep-07
Jan-10
May-12
Sep-14

RISK . . .

0%

-10%

-20%

-30%

-40%

-50%

One-Month US Treasury Bills

S&P 500 Index

$1,000,000

$100,000

$100
Jan-26
May-28
Sep-30
Jan-33
May-35
Sep-37
Jan-40
May-42
Sep-44
Jan-47
May-49
Sep-51
Jan-54
May-56
Sep-58
Jan-61
May-63
Sep-65
Jan-68
May-70
Sep-72
Jan-75
May-77
Sep-79
Jan-82
May-84
Sep-86
Jan-89
May-91
Sep-93
Jan-96
May-98
Sep-00
Jan-03
May-05
Sep-07
Jan-10
May-12
Sep-14

. . . REWARD!
Growth of $100

S&P 500 Index

One-Month US Treasury
Bills

$10,000

$1,000

MARKETS HAVE REWARDED DISCIPLINE

MSCI World Index,19702013
BusinessWeek:
The Death
of Equities

Dow drops 23% on

Black Monday

Dotcom
stock
crash

Income tax
rates rise

Arab oil
embargo

Oil prices
quadruple

Y2K
Scare
Gold hits
record high

Russian
financial
crisis

US inflation
at 13.5%

S&P 500
down 43%

1970

Savings and
loan crisis

Iraq
invades
Kuwait

1980

1990

Asian
currency
crisis

2000

Eurozone
debt crisis
S&P 500
down 46%

9/11
terrorist
attacks

US home
prices hit
bottom

Hurricanes
Katrina
and Rita
Iraq war
begins

Fiscal
cliff
worries

Subprime
mortgage
crisis

2010

2013

YOU DONT HAVE TO PICK JUST ONE

"The Lost Decade" Total Returns January 2000 - December 2009

200%

176%
154%
150%
121%
110%
100%
82%

50%

41%
28%
12%

0%
-9%

-50%

85%

92%

COMPLEX VS. SIMPLE

The Endowment Model

Asset Allocation

Opaque: Illiquid Securities,

Leverage & Little Transparency

Transparent: Liquid Holdings,

Daily Pricing & Complete
Transparency

Operationally Challenging with

Higher Fees

Operationally Ecient with Lower

Fees

Risk measurement through

complex quantitative risk models

Risk management through

intelligent asset allocation &
diversification

Try to avoid volatility

Use volatility to your advantage

and survive periods of severe
disruptions

THE DIVERSIFIED PORTFOLIO

Asset Class

Allocation

International Stocks

26%

U.S. Large Cap Stocks

18%

U.S. Investment Grade Bonds

14%

Emerging Market Stocks

9%

U.S. Mid Cap Stocks

6%

U.S. Small Cap Stocks

6%

Mortgage Backed Bonds

6%

Inflation Protected Treasury Bonds

5%

Real Estate Investment Trusts

4%

U.S. High-Yield Bonds

4%

Cash

1%

PorJolio Yield: 2.77%

Annual Expense RaSo: 0.29%

WHY INSTITUTIONAL INVESTORS UNDERPERFORM

1. High Fees Reduce Returns
2. Lack of Discipline
3. Excessive Trading / Costs
4. Incoherent Investment Philosophy
5. High Turnover
6. Over Condence
7. DeviaZng from Strategy (style drit)
8. Believing Forecasts / PredicZons
9. Over-ConcentraZon of Holdings
10. EmoZonal Decision-making

ORGANIZATIONAL ALPHA
1. Size/Ability to NegoZate Fees
2. Innite Zme horizon
3. Behavior (Crisis Alpha)
4. Investment Philosophy
5. OrganizaZonal Structure
6. Process
7. Quality Control
8. Seyng Reasonable ExpectaZons
9. CommunicaZons
10. UnemoZonal decision-making

WHAT YOU CAN CONTROL

THE WAR BETWEEN YOU AND YOUR BRAIN

Understand Risk:

a) Recognize its importance to
achieving returns;

b) Embrace appropriate levels;

c) Beware risk aversion.

KEY TAKEAWAY

Walt Kelly Pogo

1971

FOR MORE INFORMATION PLEASE CONTACT

Barry L. Ritholtz
Chairman & Chief Investment Ocer
Ritholtz Wealth Management
90 Park Avenue, 18th oor
New York, NY 10016
212-455-9122
Info@RitholtzWealth.com

My favorite books on these subjects can be found at

http://www.ritholtz.com/behavioral-books