Reading 13 onwards

Managing individual investor portfolios..

Five things to consider for IPS:

1. Liquidity needs

2. Time horizon for investing

3. Taxes

4. Legal and regulatory constraints

5. Unique circumstances

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Monte Carlo simulation: personal planning (retirement planning)

probabilistic distribution to be used: all different paths for the individual's earnings.
Normally median of distribution may be much lower than the average; fat tail... So providing client a prob distribution is quite useful.
Monte Carlo pitfalls:
a) Relying on historical data for prediction
b) Performance of specific investment relevant to user must be considered instead of general..
c) Tax consequences must be taken into account.

Inefficient market theme

Few of the important points:

1. Analysts are conservative in their forecasts, don't adjust it even in light of new info

2. P/E goes much worse than fundamentals in bad times; goes way more up in good times because of investor sentiment

3. Without any extra info, it is hard to make money even in inefficient markets

4. Long run reversion to fundamental value probably still holds true in stock market.

5. Frame dependence : from current pay, have 50% chance of pay cut or 2x pay raise, how much pay cut do you agree with.
Equity risk premium suggests 4%, but in reality people say for themselves around 23%...

paradoxes...
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Portfolios, pyramids, emotions and biases:

1. prices going down: fear -> anxiety -> regret
2. Prices going up : hope -> anticipation -> pride

'Five year window' to take money out of equities.... for future needs. Not purely related to mean, variance frontier calculations, rather also deals with emotional stuff

3. Financial engines: probability calculations, e.g. 41% chance of achieving their goals

4. Novel ideas to appeal to 'cautiously hopeful' nature:
british premium bonds: principal safety + lottery chance
principal perservation thru zero coupon bond and rest in stocks
insurance company guaranteeing x% return + half of stock market gains if any

5. Hindsight bias: People are fearful of investing in loser stocks... even though they historically outperform the market. (winner - loser effect)

6. investors underestimate beta: their stock will not be affected as much as overall market...

naive diversification: given choices in 401K account, investors just divide equally among those

7. forecast failure: analysts are good at analyzing, not forecasting... anchoring happens without realizing it. hanging onto ones' views for too long.

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13: beta grazers vs alpha hunters

Allocation alphas: akin to buying supplements in supermarket to get a balanced diet...

Rebalancing: number of institutional investors have rigid rules; not allowing them flexibility when needed. Over performers force the funds to be skewed towards them..

- The distribution of outcomes during intermediate times is much wider than the range of returns in a given horizon (end)...