Behavioural finance offers path to market recovery.

Investors could be willing to take on more risk to recoup their losses.

Behavioural finance theories are gaining prominence and could plausibly explain the wild market volatility of recent months, according to Jan Mahrt-Smith, an associate professor of finance at the University of Toronto’s Rotman School of Management.

Speaking at the University of Toronto on Tuesday, Mahrt-Smith pointed out that behavioural finance has recently gained much more attention as financial experts and commentators seek to explain the dramatic market activity of recent months.

“Behavioural finance is everywhere these days,” said Mahrt-Smith, who is also co-director of the Rotman Master of Finance Program.

One of the roles of behavioural finance, which is the study of non-rational decision-making and the ways such decisions impact financial markets, is to fill in the gaps of rational finance theories, Mahrt-Smith explained. For instance, behavioural finance acknowledges that investors have different expectations about investments, and that changes in investor confidence levels can impact the markets. In addition, the theory shows that emotions can play a role in investing.

Certain irrational investment behaviours could have played a role in adding to the market volatility of recent months. For instance, Mahrt-Smith pointed to studies showing that investors tend to focus more on gains and losses than their overall level of wealth.

“It should be only wealth matters,” he said. “But it turns out we care about gaining money or losing money much more.”

Whether a loss is big or small, it can have a significant impact on a person’s happiness, he added.

“One dollar gain is a gain, it’s fantastic. One dollar loss is a loss and it’s horrible,” Mahrt-Smith said.

The losses incurred by investors early in the downturn, therefore, could have helped trigger an irrational panicked reaction that led to a more severe selloff and added momentum to the downturn.

Some of the investment losses of recent months could also have been worsened by the tendency for investors to hold on to losing stocks longer than winning stocks -- a reality of investment behaviour, according to Mahrt-Smith.

“We’re willing to gamble that it will come back up, but we don’t want to take the loss,” he said.

He added that the recent crash could change investors’ behaviour going forward.

“We’re all poorer now, so we have to recalibrate how we think going forward,” he said. “Maybe using historical statistics isn’t going to be the same when you’re going through a period of a crash or a bubble.”

In particular, Mahrt-Smith said that even though nearly all investors have lost money in recent months, behavioural finance theory shows that they could be willing to take on more risk to recoup their losses.

“We’re going to behave quite differently from these risk-averse, rational investors,” he said. “People are going to gamble for a resurrection.”

Mahrt-Smith noted that there are some considerable arguments against using behavioural finance theories to explain the current market events. For instance, some argue that since all investors tend to behave differently, it is difficult to draw generalized conclusions about this behaviour.

Still, Mahrt-Smith said the theories represent a promising starting point for justifying some of the ways investor behaviour has played into the widespread market volatility of recent months.

(-Courtesy of: "Investment Executive - 03/18/09 Article by Megan Harman.)

What amazing times these are...

“Be careful what you water your dreams with. Water them with worry and fear and you produce weeds that choke the life from your dreams… Always be on the lookout for ways to turn a problem in to an opportunity for success.” -Lao Tzu

"Bear-Market... Shmear-Market..."

The near term will likely remain volatile, but I continue to believe periods like these create long-term opportunity... We must however navigate wisely.

We will look back on this period as one that provided fantastic entry points for long-term oriented investors.

If you are a value investor- you are a long-term investor. If you are a long-term investor- you accept in advance that you are making no effort whatsoever to keep up with your benchmark or peers on a short-term basis.

Reasons to consider investing today:

-Contrarian Sentiment: Buy when there is blood in the streets. While the current crisis has created mass fear and panic, it has also created opportune entry points for long-term investors.

-Cheap Stocks: Current S&P 500 valuations imply an extended period of extraordinarily- and unlikely- weak long-term earnings growth.

-Government Action: The U.S. Government- and others- is making an extraordinarily proactive effort to address current problems.

-Growth on Tap: While the economic global engines of growth (e.g. China, Brazil, India) have slowed, they are not broken.

-Parked Wealth: Nearly $4 trillion are currently sitting in money market funds.

-Historical Precedent: Equities have delivered 9% to 11% annualized returns in the more than eight decades through 2007... decades that include the Great Depression, World War 2, the Long-Term Capital Debacle, the Asian Contagion, Iraq Wars 1 and 2 and September 11Th.

Addition To The Corporate Bond Post... (From Warren Buffett's Recent Release)

Clinging to cash equivalents or long-term government bonds at present yields is almost certainly a terrible policy if continued for long. Holders of these instruments, of course, have felt increasingly comfortable – in fact, almost smug – in following this policy as financial turmoil has mounted. They regard their judgment confirmed when they hear commentators proclaim “cash is king,” even though that wonderful cash is earning close to nothing and will surely find its purchasing power eroded over time.

Approval, though, is not the goal of investing. In fact, approval is often counter-productive because it sedates the brain and makes it less receptive to new facts or a re-examination of conclusions formed earlier.

Beware the investment activity that produces applause; the great moves are usually greeted by yawns.

Bonds... Corporate Bonds. (Sexy no?)

Safety and security is a pressing issue now-a-days; when we see even the most rational investors of our life time acting in irrational ways. But where does one focus his investments and still guarantee a great degree of protection while beating the eroding effects of inflation? If your stomach (IE. risk tolerance) is not up to the swings of high-yielding equities (IE. companies that pay handsome dividends, etc...), then bonds are the most logical place to look... or one could simply hide under a rock until the sky is done falling... Unfortunately, most of us don't have that kind of luxury, as time is something we don't have alot of. So now more than ever, investment returns are vastly important to achieve some semblance of our former retirement dreams and aspirations.

Quick Background:
Bond prices and bond yields move in opposite directions. Prices are quoted relative to a par value of 100 - a bonds value at issue. If the bond has a 5% interest coupon, the annual yield is 5%. But if investors bid down the price of the bond in the market, and you buy at say 90, the effective yield is greater than 5%. And if you hold the bond to maturity, you'll get the 100 in principal, on top of the coupon income you've received.

If you read that bond yields have increased, it means that bond prices have declined(and vice-versa). Prices for long-term corporate bonds tend to move alot, since these prices are based on Government bonds plus a spread for greater risk. A company's sales, earnings and other financials also have a big impact. Rating agencies grade bond issuers on their ability to repay (AAA, AA, B, Etc..).

In the current market one sees great opportunities, especially in midterm corporate bonds. In 2006 and 2007 spreads were very tight. Even riskier corporate bonds weren't yielding much more than Government issues. But last fall, corporate bond prices plummeted as the credit crisis worsened. Today, spreads are more rational - they're wider.

Overall it is important to hold on to the bond until maturity to be certain to make money. Even without the glamour of stocks, there's still risk - and excitement in bonds these days.

(PLEASE CLICK ON THE LINK TO MY TEAM'S WEBSITE ON THE RIGHT SIDE OF THIS BLOG-PAGE TO FIND OUT MORE ON SOME OF THE GREAT DEALS ON CORPORATE BONDS. UNDER THE HEADING "PUBLICATIONS: CABA NEWSLETTERS"... CHEERS)

(Some information sourced from The Globe and Mail - R.O.B. 03/2009)