Two Concepts That Can Affect Your Returns


Two concepts often left out of conversations about investing are opportunity cost and endowment effect. Though different, they do overlap and can have implications for your portfolio.

Opportunity cost is what you forfeit by taking a certain course of action, even if the action is a decision not to act. Every dollar you allocate to a specific investment is a dollar not allocated to some other investment or purpose. If you allocate, say, $5,000 to stock A and stock B outperforms, your opportunity cost is the excess return you would have realized by buying stock B instead. At the same time, the money you invested in stock A costs you the opportunity of doing something else. By investing the money, you give up the chance to, say, spend it on a vacation or make a donation to your favorite charity.

The endowment effect holds that we value the things we own more than things we don’t own. In one oft-cited study, some participants were given a coffee mug for free while others were not. When the owners were asked how much they would be willing sell the coffee mugs for, they gave a price that was approximately double what those who did not receive the mugs were willing to pay for them. The mere ownership of a free coffee mug increased its value in the eyes of those who were given it. This behavior applies to many other assets as well, including investments. Combined with other biases, such as the disposition effect (an aversion to taking to a loss on a stock) and confirmation bias (seeking out information that supports your viewpoint), investors can end up holding onto investments that an objective third party would otherwise view as candidates for selling. Continue Reading »

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Highlights from this month’s AAII Journal

AAII Sentiment Survey

Even though pessimism rose to a six-week high, neutral sentiment is above 40% on back-to-back weeks for the first time since last fall. More about this week’s results.

This week’s results:
  • Bullish: 29.6%, down 0.1 points
  • Neutral: 40.6%, down 2.9 points
  • Bearish: 29.9%, up 3.0 points

Historical averages:

  • Bullish: 38.5%
  • Neutral: 31.0%
  • Bearish: 30.5%

Take the Sentiment Survey.

AAII Asset Allocation Survey

Equity allocations rose to their highest level since April 2005, while fixed-income allocations fell to their lowest level since 2009. More about the latest results.

June AAII Asset Allocation Survey results:

  • Stocks and stock funds: 68.8%, up 1.4 percentage points
  • Bonds and bond funds: 15.0%, down 0.5 percentage points
  • Cash: 16.3%, down 0.9 percentage points

June AAII Asset Allocation Details:

  • Stock Funds: 35.2%, up 2.5 percentage points
  • Stocks: 33.6%, down 1.1 percentage points
  • Bond Funds: 12.4%, up 1.0 percentage points
  • Bonds: 2.5%, down 1.5 percentage points

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The Week Ahead

Dow component JPMorgan Chase & Co. (JPM) will report on Friday as second-quarter earnings season officially starts. Joining it will be seven other S&P 500 companies: PepsiCo (PEP) on Tuesday; Fastenal Company (FAST) on Wednesday; Delta Air Lines (DAL) and Omnicom Group (OMC) on Thursday; and Citigroup (C), PNC Financial Services Group (PNC) and Wells Fargo & Co. (WFC) on Friday.

The week’s first economic reports will be the May JOLTS report on Tuesday and the Federal Reserve’s periodic Beige Book on Wednesday. Thursday will feature the June Producer Price Index (PPI). The June Consumer Price Index (CPI), June retail sales, June industrial production, May business inventories and the University of Michigan’s preliminary July consumer sentiment survey will be released on Friday.Seven Federal Reserve officials will make public appearances: San Francisco president John Williams on Monday; Governor Lael Brainard and Minneapolis president Neel Kashkari on Tuesday; Kansas City president Esther George and Chair Janet Yellen on Wednesday; Chicago president Charles Evans on Thursday and Dallas president Robert Kaplan on Friday.The Treasury Department will auction $24 billion of three-year notes on Tuesday, $20 billion of 10-year notes on Wednesday and $12 billion of 30-year bonds on Thursday.

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