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Efficient Markets and Behavioural Finance

As a first step, let me explain how efficient markets behave. Think of supply and demand. The prices of assets adjust quickly as new information arises. New information could be quarterly earnings, the CFO leaving the company or a patent approval. Anything that is linked to a company and makes economic sense. As new information comes to market, investors trade on that information and the price of the security is adjusted upwards or downwards. For every willing seller there is a willing and informed buyer and the market clears at the market price. In other words superior risk-adjusted returns cannot be achieved in an efficient market because the price of securities reflects all past and present information about the fundamentals of those companies.

However, though evidence suggests that markets are efficient, researchers have shown that sometimes securities can be mispriced for a longer period of time which translates into a market anomaly that can be exploited by informed traders and investment managers. Take for instance the internet bubble in the late 90s where everybody bought stocks in the tech sector because ‘it is a no brainer to do so’ or the more recent housing bubble where again ‘you had to own a house’ under those ridiculous conditions.

Now you must be confused. If we are living in a world where markets are efficient and investors make decisions after a thorough analysis, why do we still have mispriced assets and financial bubbles?

The answer is very simple: because we are all humans! And as humans we exhibit biases. Some of them are cognitive, being the response of faulty reasoning and some of them are emotional, stemming from past experiences, feelings and intuition.

For example you are an investor who would like to trade in the stock of Apple. Based on the information you gathered and your own assessment you conclude Apple is a good company to own. The current price at which one share of Apple trades should reflect all available information about the future upside potential and as a rational investor you think you are paying the correct price. As new information comes to market you should update your forecast about Apple in a diligent and disciplined manner. You should incorporate new information according to Bayes formula and assign a probability for that event to happen. Thomas Bayes has developed this model to determine conditional probability. It relates current to prior probability of an event.

Think of it from this perspective: the stock price will rise if interest rates fall. It means the stock will change in value if interest rates fall. Think what is the probability that the interest rates will change? You are trying to find out what is the probability the stock price will change in value and you are basing it on the probability that interest rates are going to fall. You got that probability. All of a sudden something happens at the macroeconomic level and you need to update your probability that interest rates will fall and you will also need to update the probability the stock price will change in value. This process or reassessment is done with Bayes formula. It is a way of conditioning your prior probability if new info comes out. It is simpler to use it with a decision tree.

With that in mind you should make decisions that maximise your utility function in the aforementioned case, buying more, holding it or selling the stock. Did you follow the above process precisely? If not don’t worry. It doesn’t mean you are less disciplined or less skilled than professional money managers. You have to know it is really infeasible to analyse all possible relevant data and assign a probability to each event.

Behavioural finance assumes investors employ a combination of traditional finance and psychological biases when making investment decisions.

This is the thing, the assumptions of traditional finance doesn’t always hold true. Investors don’t make decisions according to their utility function and don’t update their expectations according to Bayes formula.

People are not fully in control and rational when making decisions and this is because we lack the cognitive resources of looking at every possible situation and arriving at an optimal conclusion. Instead, we have a set of goals we would like to reach. Buying a car then a house followed by a vacation house. We take things step by step and take decisions that will help us reach objectives one after another. People’s goals are based on experiences and comparison with what other people have achieved: friends, neighbours, colleagues, public persons etc. If you succeed you will adjust your goals upwards and if you fail you will adjust them downwards. This is where behavioural biases play an important role. They shape your thought process which in turn alter your decisions. And just to give you an example, think of people who already own one car per family member and want to buy another one, just for fun. From an utility point of view do they really need another one? No, absolutely not. But what drives them to go to the dealer, test-drive it and buy it? It could be explained by a lack of self-control which is a bias. The tendency to overspend current income and forgo long-term plans. Or it could simply mean that they have a lot of money and can afford buying and keeping another car in the garage. Whichever the answer they will buy a new car. Behavioural bias attempts to explain why they make the decisions they make.

As a wealth manager and trusted advisor for high-net worth families I have an unique opportunity to work closely with them and observe their behaviours on how they run their businesses, investments, or how they perceive risks. I will guide you in the following articles on how behavioural biases influence our day-to-day lives and how we can moderate, reduce, or even eliminate them, depending on the root-cause of the bias. I am doing it because in my professional experience of more than 6 years as a wealth manager, I have not seen any advisor or portfolio manager working with his clients from a behavioural stand point and looking at understanding and shaping their relationship and strategy of investments taking this factor into account.

Working Capital Management and Commercial Finance Consulting

Without adequate information about what should be done to obtain small business loans in the current extreme circumstances, most business borrowers are increasingly confused. Business finance consulting that provides practical advice about overcoming current lending difficulties will be helpful to business owners. Nevertheless, because of a chaotic commercial financing climate, effective working capital management advice has become a valuable and rare commodity. Even though they are clearly in demand, business financing experts are simply not easy to locate.

Some very helpful and effective business finance advice is available at no cost, and business owners should usually start any search for help by reviewing such free advice first. Two notable examples of sources available for free online are The Working Capital Journal and The Commercial Mortgages Guide. However, the normal complexity of small business loans combined with a chaotic commercial lending climate is likely to increase the necessity of individualized commercial finance consulting assistance from a commercial financing expert.

Such personalized business finance consulting help will not be as easy to find as might be expected. In many cases, commercial financing advisors are not willing to charge a fixed commercial finance consulting fee that requires them to spend more time and frequently offers them much less compensation than provided by lucrative loan fees that are often well over $5000. If small business owners can find a commercial loan expert willing to provide these professional consulting services for a reasonable fixed fee, a likely cost range will be $1500 to $3000 for a basic but thorough consulting effort.

One of the most important efforts that commercial borrowers should undertake with a qualified business finance consultant is to explore contingency financing options which might be necessary due to the current upheaval in financial markets. For many years I have advocated the importance of “always having a Plan B” for working capital financing and other business financing.

Now that many banks have routinely reduced or eliminated business lines of credit or recalled commercial loans, the true value of formulating contingency plans for small business loans and commercial real estate financing has become very apparent. When they are unprepared to do so, business owners will find it much more difficult to find alternative sources for financing. With a practical contingency financing plan, business owners will not be caught by surprise and will be ready to take quick action if their current commercial lender suddenly changes course and revokes existing commercial finance agreements.

Most small business owners have their own areas of special interest in addition to a “Plan B” scenario to investigate with the help of a candid business finance consulting effort. Regardless of the specific topic, it will usually be beneficial for a business borrower to have a straightforward discussion with a small business loan expert.

In some cases, these discussions can be thought of as “getting a second opinion” for new commercial financing or refinancing of existing debt. Business owners might not have previously seen the point in paying even a modest consulting fee to get such a second opinion, but recent events have changed that perspective in most cases. Now that many banks have made it so painfully clear that they can make really big mistakes when the right questions are not asked beforehand, more and more commercial borrowers readily understand that they might need someone else looking out for their best interests.

For tasks like those described above, how should small business owners find a business finance consultant to help? One suggestion is to include the power of the internet and conduct a search for “working capital finance expert” or “commercial financing and consulting”. Hopefully you will have a Plan B to help guide you if that approach is not sufficiently effective.

Business Finance Misinformation and Confusion

Confusion about commercial loans and working capital financing seems to be increasing despite efforts by the federal government and commercial lenders to suggest that there is ample business loan funding. As a result, the actual availability of business financing for commercial finance programs such as commercial mortgages and business cash advances is unclear to most business owners.

It seems apparent that there have been many reports suggesting that normal commercial finance channels are either frozen or extremely sluggish. In reality there are probably more opportunities for commercial loan needs than suggested by such reports. However, increasing uncertainties in financial and credit markets have produced conflicting and misleading information about the availability of commercial financing. For most business owners, it is probably not clear if business finance funding is realistically available to them or not.

In spite of some admittedly bad news, there continue to be to reliable funding sources for commercial real estate loans, working capital loans and especially for business cash advances. At the same time, the current negative economic conditions will prove to be difficult for most businesses. Commercial borrowers should expect that extra efforts will be required to successfully arrange commercial financing. An especially harsh reality for business financing is that many banks have discontinued all or most of their business lending activities, often with very little advance notice.

One common example of commercial finance misinformation distorting what is actually feasible is that some kinds of commercial financing have been more disrupted than others by recent events. Commercial borrowers might be unnecessarily confused by reports that do not refer to all commercial loan situations but rather primarily apply to a very specialized form of business financing. For example, by most accounts commercial construction loans are in short supply currently. Such specialized business loans are not as easily available as they were just a few months ago, and a more accurate accounting would reflect that the number of commercial lenders currently active in construction financing has shrunk dramatically. At the same time, most commercial real estate loans without new construction have not been as severely impacted as funding requests which do involve construction financing.

Several publications have reported that most new business financing requests are on hold or have simply been rejected due to recent financial market uncertainties, and this is another example of how business finance funding reports might confuse small business owners. While the sources for this information might have been honestly told by one or more lending institutions that they are in fact deferring new commercial loan funding, this does not mean that is the case for the entire country. If the discussion involved automobile sales, it would be comparable to concluding that nobody is selling cars anywhere after learning that several major dealers and two manufacturers announced that they were going out of business due to lack of adequate sales. Just because one or more banks fail or stop making business loans, it does not mean that there are not commercial loans available from other sources.

Commercial borrowers would be wise to maintain a cautious perspective in determining how to refinance or obtain small business loans simply because the banking industry has been involved in financial disruptions of an epic proportion. Many banks are sounding and acting like they have been through the equivalent of a train wreck. In such a natural disaster, it might not be prudent for business owners to seek the advice of banks which effectively caused the train to derail in the first place.

Despite reports about limited availability of business financing, some commercial lending activities such as business cash advance programs are actually as active as they have ever been. In the current commercial funding crisis, small business owners should seek a commercial loans expert for a realistic assessment and candid discussion about working capital loans and business finance programs.

The Best Car Insurance Rates

If your car insurance is due for renewal and you are considering buying another policy then this article will provide you with important facts that you should know about. Car insurance policies are getting increasingly expensive and you should do all that you can to reduce your costs. How much you have to pay for your car insurance is dictated by a variety of factors as they apply to you and your vehicle.

In this article we will examine coverage limits, your age, gender and marital status, your location and insuring other household members. All of these factors will have a great influence on how much you will have to pay for your policy.

Coverage limits are generally dictated by the price that you are willing to pay for your insurance. A higher level of coverage will generally result in higher premiums. The best way to find a good value policy is to comparison shop. Nowadays it is generally accepted that the best way to do this is by using a car insurance comparison website.

Your age, gender and marital status will have a great effect on the auto insurance rates that you are offered. Insurers rate drivers using a variety of criteria, if you are a young single male driver you will usually have to pay higher rates. If you are a middle-aged female married driver then your rates will be lower. Insurers calculate the best car insurance rates for you by comparing levels of risk. Those groups which are statistically more likely to be involved in an accident have to pay correspondingly higher rates.

Location plays an important part in deciding how much your premiums will cost. Drivers who live in an urban environment will usually pay more than those from a rural area. This is because drivers who live in cities and heavily populated areas are more likely to be involved in an accident, or to have their car stolen or vandalized. Insurers generally offer better rates if you’re able to demonstrate that you keep your vehicle in a garage at night. You may also be able to improve the security arrangements of your automobile by fitting an alarm, immobilizer and steering wheel lock.

Insuring other household members will have an influence on the cost of your policy and the best car insurance rates that you offered. If you have teenage family members living with you and they are added to your policy, then your costs will increase. This may still work out cheaper than if your teenage driver were to have a separate policy in their own name.

In conclusion, there are a variety of different factors which can affect your ability to be offered the best insurance rates. Some of these are coverage limits, how old you are, whether you are male or female and whether you are married or single. Your rates will also be affected by the area where you live and whether other household members are included in your policy.