I am trying to understand the example of self control (related to frame dependence) in schweser. They basically say a younger person might avoid high paying dividend stocks due to taxes, but a retired investor might use dividends as a self-imposed control mechanism to “avoid spending the capital” in his retirement account. Self control is defined as “controlling one’s emotions”. Since this is a form of frame dependence I can safely say that the decision made by the retired investor is not optimal (made with only pure economic decisions). I am trying to understand why it isn’t, while recognizing that a total return approach is economically better. 1. Does his fear (emotion) of running out of or spending capital lead him choose high dividend paying stocks because spending the cash flow from divindeds isn’t touching the capital in his mind? 2. So he is afraid of spending his capital, how exactly does this relate to frame dependence? I can see this more as a rule of thumb (only spending cash flows will make my portfolio last) vs a total return approach, which would lead me to think a heuristic bias 3. How are huerisitics and frame dependence related?
Are they saying it’s bad for the old guy b/c he’s living off income instead of selling stocks that have appreciated and are now overvalued?
I don’t think so ng. I think they are saying that there are better ways to avoid spending capital then grabbing up as much bonds and high paying dividend stocks as he can and living off the cash flow.
mwvt9 Wrote: ------------------------------------------------------- > 1. Does his fear (emotion) of running out of or > spending capital lead him choose high dividend > paying stocks because spending the cash flow from > divindeds isn’t touching the capital in his mind? Yes > 2. So he is afraid of spending his capital, how > exactly does this relate to frame dependence? I > can see this more as a rule of thumb (only > spending cash flows will make my portfolio last) > vs a total return approach, which would lead me to > think a heuristic bias I assume it is frame dependence because they see the dividend flow in as income and no longer thing of it as a part of their investment portfolio. That’s just a guess though. > > 3. How are huerisitics and frame dependence > related? I don’t know that they are directly related. With all of that said, based on the wording of the LOS I think a question on self control would just be behavior related, which you already know: Reading 8: Frame Dependence: The Second Theme The candidate should be able to: a. explain how loss aversion can result in investors’ willingness to hold on to deteriorating investment positions; b. evaluate the impacts that the emotional frames of self-control, regret minimization, and money illusion have on investor behavior.
for the first question, the answer is yet. But forget about what you know, have ever met a retired dude or granny who keeps complain every day about his/her portfolio is this or that? Those ppl care a lot about dividends because If they have to draw on the capital, they feel very miserable, even if it one penny. Therefore, in the mind ( the way they frame they thinking ) is that dividend is very important to them. As a result, they will frame they thinking as if was all about dividend. if a stock don’t pay dividends, forget about and even in fact that investment is not optimal. Therefore, they will judge the goodness of the stock based on how much they get from it in term of dividend because they depend on these dividend to survive. That is the frame dependence bro. This is the way they see their world. You as an PM, you sometime have to make they wish come true.
Thanks guys.
3: “How are huerisitics and frame dependence related?” - Both are based on past experience and bias/influence investment decisions. Heuristics are “rules” that investors make up based on past experiences. For example: if X leading market indicator is positive, then buy stocks. Or if a company anounces they beat earnings, then invest in that company. Frame dependence means that you interpret information differently depending on the context. So seeing the X leading market indicator in a down market would mean something different to you than than seeing the same leading indicator in an up market. Or if you hold a stock that is currently at a loss that beats earnings, interpretting the information differently if you are holding that same stock as a gain. 1: "Does his fear (emotion) of running out of or spending capital lead him choose high dividend paying stocks because spending the cash flow from divindeds isn’t touching the capital in his mind? " - YES In the case of the investor who holds dividend paying investments in order to avoid having to sell anything (living off of the income), the investor is attempting to avoid “fear of regret”. 2. “So he is afraid of spending his capital, how exactly does this relate to frame dependence? I can see this more as a rule of thumb (only spending cash flows will make my portfolio last) vs a total return approach, which would lead me to think a heuristic bias.” - The decision is based on the “frame” of how the gains are received. Dividends are OK to use, capital gains should be left in the portfolio to grow. It’s sort of semantics, you just have to figure out what category each thing falls into most closely. However, in this case, the investor has not observed anything in the past that would lead them to make a decision to “only spend dividends”. Instead, his decision is based on the way the returns are received. Cash dividends are viewed in a certain way, and capital gains are viewed in another. Two different frames for what to a rationale investor would be theoretically the same thing.
Okay I get it now. Not spending down capital should be a function of the required return (taking into RR/TTLLU). The reutrn is composed of capital gains + interest and dividends. We as mostly rational PMs looks at them all as one source of return, where our whacked out investor looks at each return component in a totally different light. See any holes in that?
mwvt9 Wrote: ------------------------------------------------------- > Okay I get it now. > > Not spending down capital should be a function of > the required return (taking into RR/TTLLU). The > reutrn is composed of capital gains + interest and > dividends. We as mostly rational PMs looks at > them all as one source of return, where our > whacked out investor looks at each return > component in a totally different light. > > See any holes in that? Right, I see this fairly often where I work. “Mr. and Mrs. Client, we would recommend that you sell these dog-crap bank preferred stocks.” “But Dwight, we really need the income! We can’t sell those!”
Coooooooooool.