In this Capstone project, you will have to choose between three different characters (each with a unique set of financial constraints and objectives) and design an appropriate wealth plan for them over the next 5 years. You will have to use the knowledge you gained in each of the four preceding courses to reach that objective. Indeed, you will need to know which assets to consider and how to manage them depending on changes in the economic outlook (Course 1), how to evaluate and deal with your character's emotional biases in order to suggest them a wealth strategy they will be able to follow (Course 2), how to build an optimal portfolio and manage its risk once the strategy has been designed (Course 3) and how to adequately measure the performance of your plan while taking advantage of investment vehicles and future trends in the investment management industry to further your character's goals (Course 4). This Capstone project was designed in collaboration with UBS, our corporate partner, who benefits from years of experience in guiding clients with their wealth planning.
Why we trade
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En provenance du cours de University of Geneva
Planning your Client's Wealth over a 5-year Horizon
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University of Geneva- Michel GirardinLecturer in Macro-Finance - Project Leader for the "Investment Management" specialization
Geneva Finance Research Institute
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Why do we invest in financial markets instead of just
putting all money into simple almost risk-free savings accounts?
Now the first answer you might want to give is, well, financial gain,
increasing personal wealth.
Savings accounts, while they give a steady return,
that return often barely offsets inflation rates.
So it's not very desirable and
not a good investment in terms of increasing personal wealth.
Now, the second set of answers is also the kind of answers
that somebody who enjoys gambling would give you.
All right, they do it for the thrill, they do it for the uncertainty,
not knowing what is going to happen.
They like the emotions behind the gamble, or in this, case behind the investment.
That is to say that we enjoy emotions that the market events trigger in us.
But I could also come back to the first motive,
the one where people say they want to increase personal wealth.
And I could ask you, why do you want to increase personal wealth?
And the answer is likely going to be something like, I would like to retire
early, have a nice retirement, secure the financial future for my children.
Some kind of personal motive.
So, this seemingly objective goal of increasing personal wealth,
is really also driven by personal and emotional needs.
The third motive relates to things like status and value.
That is, how do other people perceived us when they know that we are investors,
when they know what we invest in?
We may enjoy outperforming our peers, our family, our friends.
We may enjoy saying, I knew it, even though we didn't.
The first of these three motives is really the only one from which you can
derive a purely return maximization strategy.
And by return, here, I mean financial return.
The other two motives indicate that you're willing to give up money to pay a price
to satisfy emotional or personal needs.
If you're truly interested in maximizing personal financial gain,
then you need to learn to identify the second and third motive in yourself,
and eliminate them from your decision-making process.
Now, if you're interested in investing in the market, primarily for
the gambling aspect, there's nothing wrong with this per say.
You just need to understand how this is going to affect you financially.
You need to develop a strategy that is not going to hurt you financially in
the long run.
We have already seen that risk avoidance is rooted in emotions, in particular,
in fear.
But fear isn't the only emotion that you experience when you're trading in markets.
Different market events are accompanied by different physiological and
emotional responses.
So anytime you experience a gain or
loss, you will also experience some form of physiological or emotional response.
And it is important to know that the reward that we experience when we receive
financial gains, from a neuro-perspective, from the perspective of our brain,
they're not different from the reward we experience when we get food or cocaine.
All right, it's the same region in the brain that processes these rewards.
The same is true for losses.
So, the losses are also processed in regions of the brain that
process other negative stimuli, such as pain, disgust or danger.
Now besides these basic emotions like happiness and
fear in response to gains and losses, you will also experience
other emotions such as anxiety, anger, hope, greed.
And all of those will influence the financial decisions that
you're going to make.
Now, while your rational self may be able to work out the math and tell you what
are true expected returns and risks, your emotions are not that good at this.
So you will experience emotional and
physiological responses to both virtual and real losses and gains.
And this isn't just true for novices or
non-professional traders, it is actually also true for professional traders.
They, too, experience emotional and
physiological responses as a result of market events.
One interesting observation is that our trading decisions can at least in part
be explained by cognitive biases and emotions.
That is, if I was to look at the market, just as the actual information that's in
the market, our expected returns, risks, it will be very difficult for
me to predict what investors actually going to do.
However, if I take into account cognitive bias and emotions,
things like overconfidence for instance, I can actually
predict very well the decisions that people are going to make in the market.
Because it's really these cognitive bias and emotions that drive your decisions.
Let me give you one specific example.
What we observe in today's market is an incredibly high volume of trades.
That is, people perform a lot of transactions in the market as compared to
say, 20 or 30 years ago.
And that cannot just be explained because there may be more companies in the market
now, even when we account for that, people trade a lot.
So why is that?
Because if you just look at the said information in the market,
that doesn't trigger trades.
That should not trigger trades, right?
So if you run a computational model of the market
that will tell you trade occasionally but not as often as people do.
However, if we add to this model, then assumption that people are over confident.
So lot of people just overestimate the probability of gains of certain stocks.
Then that will result in a massive increase in trading volume.
So it is the overconfidence that potentially triggers trades.
That is to say, the simple belief that a stock is going to perform
better than it actually will, can trigger a lot of trades which will
not generally result in better portfolio performance.
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