Inside the Mind of Wall Street Investors Developing Investment Confidence

1. Inside the Mind of Wall Street InvestorsDeveloping Investment Confidence 5th Annual Economic & Financial Development Conference The Road to Recovery: Caribbean’s Economic Development & Pension Funds Biltmore Hotel Miami, Florida - USA July 14, 2010

2. Let’s Make a Deal Management 310

3. The Monty Hall Problem Suppose you're on a game show, and you're given the choice of three doors: Behind one door is a car; behind the others, goats. You pick a door, say No. 1, and the host, who knows what's behind the doors, opens another door, say No. 3, which has a goat. He then says to you, "Do you want to pick door No. 2?" Is it to your advantage to switch your choice? Source: Craig F. Whitaker, Ask Marilyn, Parade Magazine Management 310

4. The Monty Hall Problem What are the odds of winning if you switch your choice after being shown a door with a goat? Management 310

5. Behavioral Finance… • Explores how people make decisions about money • Highlights common “decision traps” • Provides insights for making better decisions Management 310

6. Monty Hall -- Monte Carlo Test strategy: always switch Monty Hall: mix cards and place face down goat goat car Contestant: point to a card Monty Hall: turn over a black card Contestant: switch choice; turn over card Management 310

7. The Monty Hall Problem Now what do you think the odds are of winning if you switch? Management 310

8. Solving Monty Hall with Logic Goat 1 Goat 2 Pick show switch to Win Goat 2 Goat 1 show switch to 3 possible initial choices Win Pick Goat 1 Goat 2 switch to show Pick -or- Lose Goat 2 Goat 1 show switch to Management 310

9. The Monty Hall Solution Pick either of the 2 goats initially then switch and you WIN. Pick the car initially then switch and you LOSE. The odds are of winning if you switch? 2 out of 3 Management 310

10. Insight #1: Intuition Often Fails Making financial decisions based on intuition or “gut” feel often fails. For decisions that can be aided by analysis, DO THE ANALYSIS! Management 310

11. Intuition vs Analysis 11/30/2000 Money Market Fund yield = 6.36% 2 Yr Treasury Note yield = 5.88% Intuition suggests: No brainer; “no risk” MMF has higher yield Analysis reveals: MMF wins unless rates go down ≈ 0.55% MMF has reinvestment risk Management 310

12. Opportunities for Analysis Evaluating investment strategies under different interest rate scenarios. Evaluating use of compensating balances versus hard dollar fee. Evaluating fixed versus floating rate debt. Your example: Management 310

13. Test of Overconfidence Range (90% Confidence) Low High 19 1. Joan of Arc’s age at death 4,160 2. Length of Great Wall of China (in miles) 61 3. Number of territories in Africa 29,028 4. Height of Mt. Everest (in feet) Management 310

14. Test of Overconfidence Range (90% Confidence) Low High 1452 5. Year in which Leonardo da Vinci was born 24,902 6. Circumference of the Earth at the equator (in miles) 400,000 7. Weight of a large blue whale (in pounds) Management 310

15. Test of Overconfidence Range (90% Confidence) Low High 1 in 175,711,536 8. Odds of winning Mega Millions lottery jackpot (1 in ???). 11,353,140 9. Population of Ohio 3,000 10. Number of cover versions of “Yesterday” by The Beatles Management 310

16. Insight #2: We are Overconfident If you are accurate in assessing with 90% confidence, you should miss 1 out of 10. Studies show people are routinely overconfident… …especially in areas where they have expertise. Management 310

17. What the experts say Heavier-than-air flying machines are impossible. Lord Kelvin—President of the British Royal Society, c. 1895. A severe depression like that of 1920-21 is outside the range of probability. Harvard Economic Society—Weekly Letter November 16, 1929 They couldn’t hit an elephant at this dist___ General John B. Sedwick—Union Army Civil War officer’s last words, uttered during the battle of Spotsylvania, 1864. Management 310

18. Challenge of Economic Forecasts “The only role of stock forecasters is to make fortune-tellers look good.” Warren Buffett, Berkshire Hathaway annual report “Put five economists in a room and you’ll get six different opinions.” John Maynard Keynes, economist Management 310

19. Forecasting Interest Rates Bond market experts and economists make predictions about interest rates. The risk of these “single point” forecasts is the unreasonable confidence… ...ascribed to predicting something that is very hard to predict. Management 310

20. A More Intelligent Approach Interest rate prognosticators are wrong more often than they are right. A more intelligent approach would be to evaluate portfolio strategies under both rising and falling interest rate scenarios. Management 310

21. You’re the Expert 3 Mo. T-Bill Yield: 11/30/07 = 3.15% Low High Your estimate of T-Bill yield 12 months from now (with 90% confidence) 1.67% 4.63% Statistical estimate (with 90% confidence; 1.64 std. dev.) Management 310

22. Consequences of Overconfidence Failure to consider reasonable possibilities. Ignore risks that you don’t see. Have you ever been overconfident? Write an example: Management 310

23. Cure for Overconfidence Recognize that we are all susceptible to overconfidence. Develop a disciplined process for making decisions. Per Dr. Van Tharp, the most important determinant in investment success is not strategy or style, but rather articulating and following a disciplined process. Management 310

24. Solving the Right Problem Analyzing a problem instead of relying on intuition… …and guarding against overconfidence… …will not help if you tackle the wrong problem. Management 310

25. How We See Things This glass is half How we phrase an issue affects how we address it. Management 310

26. Solving the Right Problem “Hardly ever do we spontaneously alter the formulation of a problem that is presented to us in a reasonably clear and complete way.” --Massimo Piattelli-Palmarini, MIT In behavioral finance, this is called the “framing effect.” Management 310

27. Insight #3: We Plunge In People tend to gather information and reach conclusions without first thinking about the crux of the issue. Plunging in on the wrong problem can be very costly in time and money. Management 310

28. E = mc2 Einstein succeeded where his contemporaries failed because he solved a different problem. Instead of asking, “How can nature appear to act that way when we know that it can’t?” He asked, “What would nature be like if it did act the way we observe it to act?” Management 310

29. The Investment Problem One approach is: How can we maximize yield? Write an alternate question: How can we maximize return? How does the rephrasing of the question affect the solution? Management 310

30. Yes No Framing: Yardsticks Situation A: You are in a store about to buy a watch that costs $70. A friend tells you an identical watch is available in another store two blocks away for $40. Will you travel two blocks to save $30? Management 310 Source: Thaler

31. Yes No Framing: Yardsticks Situation B: You are in a store about to buy a video camera that costs $800. A friend tells you an identical camera is available in another store two blocks away for $770. Will you travel two blocks to save $30? Management 310 Source: Thaler

32. Framing: Yardsticks In Studies: Sit. A: 90% of people will travel 2 blocks. Sit. B: 50% of people will travel 2 blocks. People think about savings in percentages, not absolute dollars. Management 310 Source: Thaler

33. Investment Yardsticks List two yardsticks for measuring investment performance. 1. 2. How does the choice of the yardstick affect your decisions? Management 310 Source: Thaler

34. How to Solve the Right Problem Given the consequences of tackling the wrong problem, it is critical that you tackle the right one. Recognize the tendency to jump in and solve any reasonably posed problem. Ask yourself—and everyone involved—have we framed the right problem? Management 310 Source: Thaler

35. Get Whacked Utilize tools that assist you in viewing issues in more than one way. Roger von Oech – Creative WhackPack “It’s easy to come up with new ideas, the hard part is letting go of what worked for you two years ago, but will soon be out-of-date.” Roger Von Oech “It’s important for the explorer to be willing to be led astray.” Roger Von Oech Management 310 Source: von Oech

36. Get Whacked Challenge the Rules 19. According to ancient prophesy, whoever could untie the “Gordian Knot” was destined to become King of Asia. All who tried failed to solve this complicated puzzle. Then Alexander the Great had a turn. Management 310 Source: von Oech

37. Get Whacked Challenge the Rules After fruitless attempts to find a starting point, he was stymied. Finally, he said, “I’ll just have to make up my own knot-untying rules.” He pulled out his sword and sliced the knot in half. Asia was fated to him. Management 310 Source: von Oech

38. Get Whacked Challenge the Rules Most advances have occurred when someone challenged the rules and tried a different approach. What rules can you challenge? Management 310 Source: von Oech

39. Get Whacked Additional WhackPack Questions: What different ideas can you combine? What’s your blind spot? Where does ego adversely affect your performance? What are you dissatisfied about? How can you turn irritation into inspiration? Management 310 Source: von Oech

40. Summary: 4 Key Insights 1. Spend time to properly frame the issue. 2. Guard against overconfidence. 3. Be careful of relying on intuition. If a problem is subject to analysis, do the analysis. 4. “It’s easy to come up with new ideas, the hard part is letting go of what worked for you two years ago, but will soon be out-of-date.” Management 310

41. Questions Contact Information Orvell Johns orvelljohns@hotmail.com Management 310