As you might imagine, even though we’re long-term investors here at Minerva, it’s difficult to avoid following the market on a day-to-day basis. One thing that’s been striking of late, as well as for significant periods over the last few years has been the market volatility.

While some portion of the volatility is related to concerns about value, much of it is driven by pure psychology. Couple this volatility with the fact that studies have shown the average investor in mutual funds does a good bit worse than the average fund itself (because many buy high and sell low), and it’s clear that psychology plays a large – and often detrimental – role in investing. The first article below is an introduction to cognitive biases, pitfalls that often impact investors. In future newsletters, I’ll cover some of the most common biases, how they impact investors and what can be done to avoid them.

The financial planning tip of the month covers charities, and more specifically one key piece of information you should seek from charities that solicit your donation. Finally, the question of the month is about inflation, and whether or not it’s still a concern over the short term.

As always, feel free to forward this newsletter on to friends and family if you think it would be of use, and if you have any questions or suggestions, don’t hesitate to let us know.

Best regards,

Micah Porter, CFA, CFP®

An introduction to cognitive bias

Micah Porter, CFA, CFP®

Years ago, one of the first courses I took in college was introduction to cognition, or the science of human thought. One of the concepts that stuck with me long after the course, was the idea of a heuristic – a mental rule of thumb – or shortcut, that we all use in certain situations to quickly come to a decision.

Within the framework of cognition, the alternative to a heuristic is a more arduous process of collecting all relevant information and systematic reasoning to reach a decision. Given that we often don’t have the time or inclination to take the long way to a decision, heuristics are tools we all use.

Fast forward a few decades, and I find myself thinking about heuristics again in the context of investing and financial decision-making. Understanding when you may be subject to a particular bias can help improve your financial decision-making, but it can also provide a bit of peace-of-mind amidst the onslaught of news and opinion we seem to be subject to these days. While you can’t necessarily avoid the initial impulse biases engender, recognizing them when they appear can help you take a step back and perhaps take a more systematic approach.

The first bias we’ll examine in next month’s newsletter is confirmation bias, one of the most common and in some ways pernicious. Confirmation bias helps explain why we often stick to our opinions even when the objective facts underlying our opinions change, and why we are drawn to alarmist headlines that confirm our concerns but only lead us to be more upset.

Financial planning tip – Maximizing the best of intentions

Micah Porter, CFA, CFP®

Several weeks ago, we got a call from a telemarketer soliciting funds for a charity purporting to support the local police department. The telemarketers usually have a very worthy cause, one that you’d be hard-pressed to turn down. Still, whenever I get these calls, I always ask one question – what percentage is guaranteed to go to the charity itself?

In this case, the cause certainly seemed worthy – bulletproof vests for local police officers. However, when I asked what percentage would actually go towards this cause, I was told that the charity was “guaranteed to receive a minimum of 16%” of the amount donated. I told the telemarketer that I appreciated the call, but that I’d prefer to donate to a charity that was more efficient in its use of donations. The same thing has happened the handful of other times I’ve asked what percentage actually made it to the charity, as the answer has never been more than 30%.

If you get a call from a telemarketer soliciting for a charity, don’t hesitate to ask this same question. They should be able to provide this information, and if they can’t, don’t feel bad about turning down the request. Furthermore, if you’d like to do a bit more research on the charity and its efficiency, is a good clearinghouse for information and ratings on individual charities.

We’ve all got a limited amount to spend on the various items in our budgets, and charitable contributions are no exception. From my perspective, I want to maximize the good our contributions achieve, and if the bulk of those contributions are for telemarketing and administrative expenses, that’s likely not happening.

Client question of the month – Are you concerned about inflation?

Micah Porter, CFA, CFP®

Until just a month or two ago, stories abounded in the financial press about the dangers of inflation. The government, so the story went, was courting the risk of runaway inflation because of high deficit spending. In various quarterly commentaries, we pointed out that the danger of inflation in the near term was quite low because of a number of factors including:

  • A good deal of unused capacity within the economy
  • High unemployment leading to low/no wage inflation and lower consumer spending
  • Excess housing supply creating downward pressure on rents

Fast forward a few months, and now the dominant theme seems to be deflation. While deflation can be just as destructive as inflation, there is one key difference. In deflationary environments (assuming other factors remain unchanged), decreasing interest rates can increase the value of existing bonds. Thus, bond funds, particularly those with longer maturity bonds, should do relatively well assuming they manage credit risk well.

Certainly, at some point interest rates and inflation will rise from their current levels, but for the time being increases appear unlikely.