Understanding investor psychology

1. Understanding investor psychology Why your clients often make irrational decisions

2. Disclaimer This presentation is given by a representative of Colonial First State Investments Limited AFS License 232468 (Colonial First State). The presenter does not receive specific payments or commissions for any advice given in this presentation. The presenter, other employees and directors of Colonial First State receive salaries, bonuses and other benefits from it. Colonial First State receives fees for investments in its products. For further detail please read our Financial Services Guide (FSG) available at colonialfirststate.com.au or by contacting our Investor Service Centre on 13 13 36. All products are issued by Colonial first State Investments Limited ABN 98 002 348 352. Prospectuses or Product Disclosure Statements (PDSs) describing the products are available from Colonial First State. The relevant prospectus or PDS should be considered before making a decision about any product. This presentation does not take into account your individual objectives, financial situation or needs. You should assess whether the information is appropriate for you and consider talking to a financial adviser before making an investment decision. The information is taken from sources which are believed to be accurate but Colonial First State accepts no liability of any kind to any person who relies on the information contained in the presentation.  

3. Agenda • Understanding your clients • Investor confidence • Investor expectations • Short term focus v long term investing • Hindsight as an investment tool • Time in the market, not timing

4. Understanding your clientsGeorge Kinder’s 7 steps to money maturity Stage 1 - Childhood • Innocence • Pain Stage 2 – Adulthood • Knowledge • Understanding • Vigor Stage 3 – Maturity • Vision • Aloha

5. Understanding your clients • “Childhood” beliefs • A fool and his money are soon parted • You can’t take it with you • If it sounds to good to be true - it is • Etc • Role of the adviser: • Education of investment fundamentals • Ensuring they understand the risks and returns of investing • Interested & excited about a growth portfolio

6. Understanding your clients • More educated then ever before • Never lived through an extended Bear market as investors • Fallen back on “Childhood” beliefs • We need to better understand why they react the way they do…

7. Understanding your clients • Investor psychology is affected by: • Investor confidence • Investors expectations of risk & return

8. Investor confidence Managing your clients’ confidence levels is one of the most difficult tasks of the financial planner

9. Investor confidenceSharemarket sentiment swings 1998-2000 2001-2002 Technology bubble Sept 11 Enron Worldcom Over-confidence Under-confidence

10. Investor confidence • Managing your clients confidence levels is one of the most difficult tasks of the financial planner • Over confidence can create clients who think they know better then you • Over confident investors tend to look for the next big thing…they become traders not investors

11. Investor ConfidenceOver confidence = under performance • A survey of 78,000 US individual investor accounts between 1991 – 1996: Trading Activity Annual Return • Least active (20%) 17.5% • S&P Index 16.9% • Most active (20%) 10.0% The most active investors expected to outperform the index by 2%! Source: Odean and Barber 1998

12. Investor confidence • Managing your clients’ confidence levels is one of the most difficult tasks of the financial planner • Over confidence can create clients who think they know better then you • Over confident investors tend to look for the next big thing…they become traders not investors • Under confidence creates apathy to investing

13. Investor expectations • The surest way to manage investor confidence is to ensure their expectations are realistic in both up and down markets • “Unrealistic expectations can quickly become unfulfilled expectations and unfulfilled expectations tend to cause grief for all concerned…except lawyers and bureaucrats.” • Advising in a Bear Market • ProQuest Limited 2002

14. Investor ExpectationsSurvey results Expected annual returns for the next 10 years: Source: Paine Webber & Gallup Organization Survey July 1999

15. Investor Expectations • Investor expectations are typically centered around the potential returns they expect • But what about their expectations of risk “Each of your clients has an individual comfort zone for risk…not yours, not what you think theirs is, not their partners but their own. – knowing this enables you to properly set expectations.” Advising in a Bear Market ProQuest Limited 2002

16. Investor expectationsTalk to your clients about “risk” • Your definition will be different to theirs • Make sure you understand their definition to avoid creating inaccurate expectations • Explain the risks of their portfolios in meaningful terms • Make it personal to them, • Don’t use industry jargon • Use visual tools where possible

17. Asset class returns (%pa)Annual Returns to 31st December 2003 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 AUSTRALIAN 5.36 8.03 7.57 5.63 5.14 5.01 6.27 5.24 4.77 4.90 Cash Bonds -4.66 18.63 11.87 12.23 9.54 -1.22 12.08 5.45 8.81 3.05 -5.57 12.74 14.49 20.31 17.95 -4.97 17.85 14.60 11.76 8.80 Listed Prop Shares -8.67 20.19 14.60 12.23 11.63 16.10 4.80 10.49 -8.64 14.96 INTERNATIONAL -8.05 25.88 6.28 41.12 32.08 17.11 2.24 -9.72 -27.17 -0.52 Global shares Percentage return over 1 year to 31st December 2003. Source: UBS Warburg Australia Bank Bill Index (91 day Commonwealth Treasury Note Index pre Jan 1999), UBS Warburg Australian Composite Bond Index, S&P/ASX 200 Property Accumulation Index (ASX Property Accumulation Index pre April 2000), S&P/ASX 300 Accumulation Index, (ASX All Ordinaries Accumulation Index pre April 2000), MSCI World Price Index (A$), and the SSB World Government Bond Index *ex Australia Hedged to A. All dividens reinvested excluding fees and charges

18. Investing for growthValue of $10,000 invested Dec 1983 – Dec 2003 Collapse of Enron RussianBondCrisis 9/11 GulfWar $ AsianCrisis 1987StockmarketCrash Percentage return over 1 year to 31st December 2003. Source: UBS Warburg Australia Bank Bill Index (91 day Commonwealth Treasury Note Index pre Jan 1999), UBS Warburg Australian Composite Bond Index, S&P/ASX 200 Property Accumulation Index (ASX Property Accumulation Index pre April 2000), S&P/ASX 300 Accumulation Index, (ASX All Ordinaries Accumulation Index pre April 2000), MSCI World Price Index (A$), All dividends reinvested, excluding fees and charges

19. Investor ExpectationsTalk to your clients about “risk” • Your definition will be different to theirs • Make sure you understand their definition to avoid creating inaccurate expectations • Explain the risks of their portfolios in meaningful terms • Make it personal to them, • Don’t use industry jargon • Use visual tools where possible • Make the downside risks very clear to them up front and along the way

20. What happens if we don’t manage our clients’ expectations • Short term performance focus vs long term investing • The use of hindsight as an investment tool • The behaviour of the herd • Timing the market not spending time in the market Who to blame?

21. 12 Drat! I’ll buy in again. It’s cheaper than last time anyhow 2 The trend is holding - I’ll buy at the next consolidation 4 I’ll use this correction increase my position . . . 3 Good thing I didn’t wait! 11 This is it! I knew this was going to happen all along! 5 Ouch. As soon as it goes back up, I’m selling out! 1 Ah, the price is going up, let’s watch the market 9 It’s going to tank again anyway 10 What the hell??? 6 OK, let’s wait for it to recover- otherwise this will have to be a really looooong-term investment 7 Enough! I’m selling out! And staying out 8 Good thing I sold everything! Short term focus v long term investing

22. Short term focus vs long term investing • There are many factors influencing our clients daily: • The media • Family • Peoples inherent beliefs about money and how much they deserve • Legislated reporting requirements • As their adviser you need to be their stability • Make sure your messages are consistent • Bring them back to their long term goals at every opportunity • Keep in touch

23. Hindsight as an investment toolAsset Class Returns (%pa) as at 31st Dec 2003 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 AUSTRALIAN 5.36 8.03 7.57 5.63 5.14 5.01 6.27 5.24 4.77 4.90 Cash Bonds -4.66 18.63 11.87 12.23 9.54 -1.22 12.08 5.45 8.81 3.05 -5.57 12.74 14.49 20.31 17.95 -4.97 17.85 14.60 11.76 8.80 Listed Prop Shares -8.67 20.19 14.60 12.23 11.63 16.10 4.80 10.49 -8.64 14.96 INTERNATIONAL -8.05 25.88 6.28 41.12 32.08 17.11 2.24 -9.72 -27.17 -0.52 Global shares Percentage return over 1 year to 31st December 2003. Source: UBS Warburg Australia Bank Bill Index (91 day Commonwealth Treasury Note Index pre Jan 1999), UBS Warburg Australian Composite Bond Index, S&P/ASX 200 Property Accumulation Index (ASX Property Accumulation Index pre April 2000), S&P/ASX 300 Accumulation Index, (ASX All Ordinaries Accumulation Index pre April 2000), MSCI World Price Index (A$), and the SSB World Government Bond Index *ex Australia Hedged to A. All dividens reinvested excluding fees and charges

24. Hindsight as an investment toolFelicity & Henry • $1 to invest in 1900 • Foresight Felicity • Every year Felicity puts all her wealth in next years’ leading asset class • Hindsight Henry • Invests all his wealth in the previous years’ best performing asset class Who comes out ahead???? Source: The Economist 12 February 2000

25. Hindsight as an investment toolFelicity & Henry Investing in a balanced portfolio over the longer term will deliver results Foresight Felicity = $9.6 Quintillion Hindsight Henry = $783 Source: The Economist 12 February 2000

26.  The behaviour of the herd Often peoples approach to investing is the same Empty Restaurant Full Restaurant

27. Time in, not timing ! Percentage of periods giving negative Returns December 1980 – December 2003 Source: RIMES, Bloomberg, Colonial First State, Analysis conducted 6 month, 1, 3, 5 and 10 years rolling period returns Source: UBS Warburg Australia Bank Bill Index (91 day Commonwealth Treasury Note Index pre Jan 1999), UBS Warburg Australian Composite Bond Index, S&P/ASX 200 Property Accumulation Index (ASX Property Accumulation Index pre April 2000), S&P/ASX 300 Accumulation Index, (ASX All Ordinaries Accumulation Index pre April 2000), MSCI World Price Index (A$),

28. Time in the market, not timingAustralian shares to 30th November 2003 Source: IRESS, Colonial First State *All Ordinaries Accum Index used prior to April 2000

29. Who to blame… • Make sure it isn’t you!!! • Revisit your clients’ expectations about risk and return • If a couple, make sure both spouse’s issues are addressed • Keep in touch with clients at all times • Make use of information delivered to you by your dealer group and fund managers

30. A final word from the experts "Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.“ The Berkshire Hathaway Inc annual report 1991