Investing, IRAs, and
Behavioral Finance
BTB 1025
Matthew Zimpelman
Richard Segal
Kevin Smeaton
Why Invest?
 https://www.youtube.com/watch?v=tp6n8ChUPZA
 Understand your risk tolerance
Understanding Bonds
 How Bonds Work
 Coupon Rate vs. Interest Rate
 Receive invested amount at end of duration
 Types of Bonds
 Treasury (Government) Bonds: low risk, low return
 Municipal Bonds: tax-free interest
 Corporate Bonds: higher risk, higher return
Important Factors when Choosing a Bond
 Pricing
 Discount
 Premium
 Par Value
 Duration
 Coupon Rate
 Depends on Risk Tolerance
Understanding Stocks
 What are stocks?
 Ownership in a corporation
 Buy Low, Sell High
 Understand Return
 Dividends
 A distribution of a portion of a company's earnings, decided by the board of
directors, to a class of its shareholders.
 Shorting Stocks = Betting against a company
 Sell High, Buy Low
 Example
 Average Return on Stock Market = 10-11%
Long Term Investing Tips
 Diversification
 Investment types (Bonds vs. stocks vs. other investment types)
 Market type (Ex: automobile market)
 Be Patient
 Don’t track daily, weekly, monthly changes
 Some years you might lose money, don’t worry
 Invest Earlier = More Money = Retire Earlier!
Long Term Investment Scenario
 http://www.daveramsey.com/article/how-teens-can-
become-millionaires/lifeandmoney_kidsandmoney/
Who Wants to Be a Millionaire?
 If you took $1,000 and invested it, what would happen?
 If you waited for 50 years, you could be a millionaire!!!! (Or at
very least a hundred-thousand-aire!))
 How??? Compounding Interest and Smart Investing!
 What is compounding interest?
 Return Rates
 Historical Average Return on the Stock Market = 11%
 Aggressive Approach (Good Investing) = 15%
Path to Becoming a Millionaire!
Year
Total Amount:
Avg. Market Rate Return = 11%
Total Amount:
Aggressive Approach/ Return =
15%
0
$1,000.00
$1,000.00
1
$1,100.00
$1,150.00
2
$1,232,00
$1,322,50
10
$2,839.4
$4,045.56
20
$8,062.3
$16,366.54
35
$38,574.85
$133,175.52
50
$184,564.83
$1,083,657.44
Retirement Planning
 Save now in order to retire at younger age
 Money growth is exponential
 Different forms of retirement accounts:
 Benefit Plans (employer sponsored)
 Traditional IRAs
 Roth IRAs
 IRA—individual retirement account
 Personal account that works similar to benefit plan
Benefit Plans
 Most common is a 401k plan
 Contributions made by employee into the firm’s plan
 Sometimes employer will match your contributions up to a certain
amount
 If possible, ALWAYS contribute the MAXIMUM that the employer will
match
 Earnings are tax deferred
 Major benefit due to compound interest
 403b plan (non-profit organizations
 457b plan (governmental employers)
Traditional IRA
 Personal retirement account
 Each person allowed to contribute max $5,500
 Age 50+, can contribute additional $1,000 as “catch up”
 Earnings are tax deferred until withdrawn
 Compound interest on larger sum of money
 Because it isn’t being taxed today
 Good if tax rate is lower when money is withdrawn
Roth IRA
 Also a personal retirement account
 Max contribution is also $5,500
 Age 50+, can contribute additional $1,000 as “catch up”
 Earnings are taxed when earned
 Do not pay taxes when withdraw funds
 Good if tax rate increases over time
What is Behavioral Finance?
“The area of finance dealing with the implications of investor
reasoning errors on investment decisions and market prices”
● Reasoning Errors Occur by Investors
● Proponents of behavioral finance believe these errors cause
market inefficiencies
Introductory Activity
We give you $4000. Next, you can take one of the following two
options:
A. You can have $1000 more dollars from us
B. You can flip a coin. If it lands on heads, you get $2000
more from us. Tails, you get nothing.
Introductory Activity 2
We give you $6000. Next, you can take one of the following two
options:
A. You can lose $1000
B. You can flip a coin. Heads, you lose $2000. Tails, you lose
nothing
Frame Dependence
Both scenarios we went through were exactly the same.
● Option A: You would have ended up with $5000
● Option B: 50% chance you would have ended up
with $6000, and 50% chance of getting $4000
Therefore, you should chose the same answer in both scenarios.
Why didn’t you?
Loss Aversion
● Reluctance to selling investments after they fall in value
● Always evaluate stocks at their current price
o
Do not base on past prices
● Barings Bank and Nicholas Leeson
● Individual 1.5 times more likely to sell a gain then sell a loss
Overconfidence
● Overconfidence leads to more trading
o
more trades leads to lower relative returns
● Overtrading is “a guy thing”
o
o
men trade about 50% more than women
men have riskier portfolios than women
● 43% of households outperform market
o
lack of diversification
Misperceiving Randomness
 The Hot Hand Fallacy:
 Common misconception in sports:
 If player is doing well, he should continue to do well?
 Stats show that having “hot hand” does not increase chances of
staying “hot”
Coin flip activity
 You flip the coin one more time, do you think it will it be heads
or tails?
Overreacting to Chance
● The Gambler’s Fallacy:
o
The idea that if an event hasn’t happened recently it is
“overdue” and is bound to happen soon
● These types of cognitive errors are called “forecasting
errors”
Works Cited
 The Motely Fool
 http://www.fool.com/teens/teens01.htm
 Jordan, Bradford, Thomas Miller, Jr., and Steven Dolvin.
Fundamentals of Investments. 7th ed McGrawHill, 2015. Print.
("Hedge Fund Definition | Investopedia." Investopedia. N.p.,
n.d. Web. 23 Sept. 2014.)