1) A study found that when people learn that their choice agrees with expert opinions, the reward center of their brain is activated similarly to when experiencing pleasures like food or money. 2) This suggests that conformity feels intrinsically rewarding on a basic biological level, explaining why investor sentiment can suddenly change as people want to agree with the group. 3) When others value something differently than you initially did, it makes you question your own valuation and want to conform to be part of the group, even if just subconsciously.

1.
2010-2011 BFM
Newsletters
Summary
Founder’s word
Happy New Year!
To begin 2012 with all the tools you may need, BFM created
for you this compilation of all the newsletters of 2010 and
2011.
You will discover or rediscover the valuable information BFM
gathered under three major themes: A, B, C.
To know more about a specific subject you can also refer to the next summary:
Understanding Behavioral Finance-Rationality & Decision Making……..…………….………2
Humans can’t analyze all the information received……………………………………....….....2
Challenges in Financial Advising From the Scope of Behavioral Finance…………………..…4
Investment Decision Making………………………………………………………..............…4
Countries and Culture in Behavioral Finance………………………...…………………..……4
Human Brain and Decision-Making………………………………………………………..…5
Train Your Brain to Win Big………………………………………………………………….6
Be Aware of your Emotions - Step Away from Yourself - The Flaws of our Financial Memory……….6
So That's Why Investors Can't Think for Themselves……………………………………...…7
How to Pick Better Mutual Funds?……………………………………………………...……8
Performance May Lower your Returns…………………………………………………...….11
Let's Put Things in Perspective……………………………………………………………....12
Appendix……………………………...……………………………...…………………...…15
January
2012
© 2012 Bourbon Financial Management, LLC ~ All Rights Reserved ~ Info@bourbonfm.com ~ (+1) 312 909 6539
1

2.
Understanding Behavioral Humans can’t analyze all the
Finance-Rationality & information received
Decision Making
Behavioral Economics explains how the Please find below a one-minute video.
process of decision making functions among
common people. It elaborates on the role of
emotions and vision. Video: Selective Attention Test
We use vision more in the day than we do
anything else, so we are good at it. But the
truth is that our vision tricks us. If we have
these repeatable mistakes in vision which we This video shows that human attention is
are good at, what are the chances we don’t limited and that we can’t analyze all the
make more mistakes in that we are not good information we receive.
at, ex. financial decision making?
Do you want to know how powerfully
illusive our vision is and how it dominates We tend to pick the information that we
our decisions? need to prove that our thinking is correct. If
we are bullish and long the financial market,
we tend to read bullish reports. Individuals
See the entire Newsletter at:
Newsletter, January 2011
have a tendency to simplify decisions (good
company -> good investment, momentum
strategies -> chasing performance).
Furthermore, investors believe their
information is correct and they are better at
If you want to learn more about interpreting information and making
behavioral finance and the role of decisions. We have an inability to fully
Psychology, here is a long and incorporate new information into risk and
popular video (viewed 28,000 return forecasts. The failure to recognize the
times!) of a class of Robert Shiller, true risk of an investment makes us trade
Professor of Economics at Yale more frequently than can be justified by the
University.
information. Also, we tend to remember
only the good decisions so our memories
Behavioral Finance : The Role of
don’t disagree with our opinion on our
Psychology
abilities.
Refer to “We are all Predictability
Irrational - Dan Ariely” on YouTube
link:
We are All Predictably Irrational
2

3.
See More tricks at:
The Human
Brain…tricks us
whenever it can!
3

4.
Challenges in Financial
Investment Decision
Advising From the Scope
of Behavioral Finance
Making
In today’s world, especially after the recent Since many of you like Behavioral Finance
financial meltdown, understanding the research to help you improve your decision
human emotions and sentiments before making process,
investing money is capturing interests of
researchers and advisers. We too continue
our long love with Behavioral Finance and
present you some interesting findings by Please find the Newsletter
researchers in this area. « Investment Decision Making » at:
Newsletter, May 2011
Please see the Newsletter to learn
more about:
Newsletter, July 2011 You will find some information about:
• Intuitive and Reflective Minds • Asset Allocation
• Investor Paralysis • Information Overload
• Lack of Investor Discipline • The Effect of Myopia and Loss
Aversion on Risk Taking
• Regaining and Maintaining Trust
• Making Intelligent Decisions
• Overcoming Loss Aversion
• The practices that an investor
• Overcoming Procrastination should try to follow
• The Ulysses Strategy • Some things that an investor
should try not to engage in
Countries and Culture in Behavioral Finance
Have you analyzed why Chinese exhibit higher risk tolerance than Americans? Have you ever
wondered how Muslims invest money? And did you know a country’s corruption level has an
impact on its own diplomats?
Asians, Americans, Europeans, Africans, Australians… The world is a mix of people from these
continents with different ideologies and cultures. But what is fascinating is that there is
something which is common between these diverse cultures. Guess what? It is MONEY!
Find all the answers at: Newsletter, June 2011
4

5.
We can summarize some of the practices that should be followed:
· Financial advisers need to probe their clients more about their culture. Also important is
to know the client’s obligations towards others. Individualistic and collectivistic groups have
different styles of thinking. This reflected in their investment decisions.
· Continuously strive to learn more about investing.
· Understand the complexities in investing. The adviser will have to do more research and
be sure that he does not fail his fiduciary duty.
· Saving rates depend a lot on culture. It is important to understand your culture before
you make investment decisions. Higher saving rates cultures are more risk tolerant that low
saving rate cultures.
· Many investors exhibit different abilities and willingness towards risk. Always honor the
willingness to risk because the investor feels comfortable if his risk level is under his/her
control.
Human Brain and Decision-Making
We can point to some general practices that can • Avoiding making any important investment
help investors improve their investment decision decision while being in a passive state of
making: mind.
• Thinking more analytically when making
important financial decisions. • Creating a balance between being patient
and being dynamic about investment
choices.
• Being pro-active, curious and non-
assumptive at all times and spending time to
evaluate investments, possible risks and
benefits.
Let’s see the Newsletter « Human
Brain and Decision-Making » for
• Continuously striving towards improving
more information, August 2011
self-control and avoiding hastiness.
5

6.
Be Aware of your Emotions
Train Your Brain to Win Big
- Step Away from Yourself -
The Flaws of our Financial
Memory
When Playing the investing game, it’s easy
to let your impulse make all the wrong See
the
entire
Newsletter
at:
moves. Learning to trick yourself can help. Newsletter,
November
2011
Why do smart people do such stupid things
with their money? The answer often lies in
neuroeconomics, a hybrid of neuroscience, · Be aware of your own emotions
economics, and psychology that drills down and cognitive traps to make smarter
to the biological bedrock of decision- decisions.
making.
· Step away from yourselves to be
Even when we think we are being rational, more rational.
we are often driven by impetuous emotions
of which we are barely conscious. Therefore, · Remember that we unconsciously
the keys to investing success, whether it’s for make decisions based on positive
retirement or just for fun, are strategies and memories.
tricks to prevent the heat of the moment
from melting your better judgment. · Learn about financial history to
reduce the number of mistakes. Do
not extrapolate recent past.
Ten Tricks for Better Investing:
· Keep a well-diversified portfolio
T ake the Global View and an investment diary.
H ope for the Best-But Expect the Worst
I nvestigate Then Invest · Have a Financial Plan.
N ever Say Always
K now What you Don’t Know
“when we’re feeling good.
T he Past Is Not a Prologue Complex decisions, involving
W eigh What They Say
I f it Sounds Too Good to Be True, It multiple options… demand our
Probably Is best thinking. Yet those very
C osts are Killers
E ggs Go Splat
decisions seem to induce in us
emotional reactions that impair
our ability to do just the kind of
The article: Train your Brain to Win thinking that is necessary.”
Barry Schwartz
6

7.
So That's Why Investors
In the experiment, researchers from
Can't Think for Themselves University College London and Aarhus
University in Denmark asked 28 people to
submit a list of songs they wanted to buy
online and then to decide which they
would most like to own. Then the
From February through May, the Dow participants viewed the ratings of the
Jones Industrial Average gained more same songs by two professional music
than 1000 points in an almost experts. Meanwhile, a magnetic resonance
uninterrupted daily march upward. Then imaging machine recorded the patterns of
came the "flash crash" of May 6 and day activity in their brains. Finally, as a way to
after day of losses through May. Now, in measure the influence of the experts'
mid-June, the market has been up six of views, the participants had the chance to
the past seven days. change their minds about which songs
they wanted the most.
What accounts for these sudden moves?
Why do investors so often seem to
The brain scans showed that as soon as
resemble a school of fish, all changing
people learned they had chosen the same
direction together?
song as the experts, cells in the ventral
Sometimes the most interesting answers
striatum—a reward center wired with
to financial questions come from
dopamine neurons that
scientific labs. A study
respond to pleasures like
published in the journal
Current Biology found that "When someone sugar and sex—fired
intensely.
the value you place on influences you, it
something is likely to go up happens very quickly,
when other people tell you it "If someone agrees with
is worth more than you in under a second," your choice, it's
thought, and down when intrinsically rewarding in
others say it is worth less. Daniel Campbell- the same way food or
money is rewarding,"
More strikingly, if your Meiklejohn
says one of the
evaluation agrees with what
others tell you, then a part of experimenters, Chris
your brain that specializes in Frith of University
processing rewards kicks College London.
into high gear.
Why might other people's estimates of
In other words, investors often go along what something is worth lead you to
with the crowd because—at the most change your own? Their appraisal could
basic biological level—conformity feels make you unsure that yours is correct.
good. Moving in herds doesn't just give You might become more popular once
investors a sense of "safety in numbers." you agree with others, or joining the
It also gives them pleasure. experts may make you feel like one
yourself. "We are very social creatures,"
That may help explain why market says Prof. Frith, "and we are desperately
sentiment can change so swiftly, why true keen to be part of the group."
contrarians are so hard to find and why
investors care so much about the "When someone influences you, it
"consensus view" on Wall Street. happens very quickly, in under a second,"
7

8.
says the lead researcher, Daniel Campbell-
Meiklejohn of Aarhus University. "That How to Pick Better Mutual
mechanism can travel quite quickly
through a population." Funds?
The experiment also showed that learning
that the experts agree with one another—
regardless of whether you agree with
them—triggers activity in the insula, a
brain region associated with pain and See the entire Newsletter at:
heightened body awareness. This suggests Newsletter, October 2011
that the agreement of others may have a
special ability to grab our mental
attention. No wonder a consensus
opinion is almost impossible for many PEOPLE + PROCESS +
investors to ignore. PHILOSOPHY = PERFORMANCE
Benjamin Graham, the founder of value
investing, wrote that "the market is not a
weighing machine, on which the value of At BFM, we are very analytical and we
each issue is recorded by an exact and believe that asset allocation is more
impersonal mechanism, in accordance important than stocks or mutual fund
with its specific qualities." Rather, he selection…but many of you have asked us to
added, "the market is a voting machine, share our disciplined due diligence
whereon countless individuals register process to selecting investment managers
choices which are the product partly of and mutual funds.
reason and partly of emotion." Herding,
Graham understood, is part of the human You should not be over confident in
condition. pursuing activities beyond your
expertise. For example, practicing skydiving
Thus, if you buy individual stocks, you without a professional skydiver or dancing
should note which way the herd is Ballet without a ballerina’s guidance can
moving—and go the other way. You harm your body. Investing your wealth, just
should get interested in a stock when its like skydiving and ballet dancing, is science
price gets trampled flat by investors but also an art. Investing without
stampeding out of it. The list of new 52- knowledge is like jumping into a valley
week lows is a rough guide to what the without a parachute.
voting machine has been trashing lately.
Then run your own weighing machine,
studying the company's financial Selecting a good mutual fund is extremely
statements, products and competitors to difficult. Only 20% of funds may
determine the value of its business—while outperform their benchmark over the long
ignoring the current price of its stock. And run. 40% of funds that were in business 10
make a permanent record that thoroughly years ago are now gone. A fund can be at
details your rationale for making the the top one period and be at the bottom the
investment. That way, you set in stone next one.
exactly where you stood before the herd
began trying to sweep you away. (Source: As you can see, mutual fund returns can be
WSJ-06/21/10 very different. Thus, effective organized
financial planning is important.
8

9.
The debate between active and passive Short-term greed and impatience will lead
management (investing in index, passive investors to fail. Before investing you should
funds and ETFs) is a constant discussion develop confidence in the fund and the
among individuals in the financial world. patience required for long-term success.
There are qualitative and quantitative factors Otherwise, you should invest in index and
that need to be understood and analyzed passive funds (low costs).
correctly before picking a good fund.
You should decide to be Human emotions are the
either patient with active “Do not wish for quick biggest obstacle to investor
managers or seek a results, nor look for success. Proper research goes
passively managed small advantages. If you well beyond the numbers. It also
approach. The vast majority requires regular meetings or calls
seek quick results, you with the managers. Natural
of long-term top will not attain the
performing managers will human behavioral tendencies
endure periods of lousy
ultimate goal.” during the manager selection
performance. and termination process
Confucius. generally leads to failure so we
· 85 percent of all ten- recommend a rigorous process.
year top quartile funds spent
We believe that qualitative
at least one three-year stretch metrics for selecting mutual
in the bottom half of their peer group (they funds are as important as quantitative
spent about 23 percent of all their three-year metrics.
periods in the bottom half of their peer
groups).
· 62 percent of ten-year top quartile
funds spent at least one five-year stretch in
the bottom half (19 percent of rolling five-
year periods in the bottom half of their peer
groups). Source DiMeo.
9

10.
What traits and factors do we look for, Quantitative factors:
review carefully, and monitor constantly?
1. Fees/ Expense ratio: Funds in the
Qualitative factors: cheapest quintile were more than twice as
likely to beat the average for their categories
1. People: education, qualifications, than the most expensive quintile
experience, depth, stability, diversity, quality
and diligence of the investment team 2. Tenure / Experience / Track Record of
(portfolio managers, analysts, traders, the Portfolio Managers and Analysts. The
auditors…) average tenure maybe close to 6 years
only…
2. Investment philosophy that is
consistent, clearly articulated and 3. Fund ownership** by the portfolio
understandable management team
3. Investment process and style based on 4. 5 and 10-year Information Ratio (IR)
meritocracy that are transparent, repeatable, and peer ranking. The IR measures the risk-
consistent, and definable with good buy and adjusted return for assessing the
sell discipline and risk management performance of active portfolio managers
procedures
5. Long-term after tax
4. Stewardship: a corporate culture of return/performance: GMO Emerging
excellence, with clean regulatory history, Country Debt had a 10-year annual return
board integrity, independence, ownership was 14.54% ($10,000 became $38,880) but
and compensation who will put your after tax, the post-tax return was 9.80%
interests first ($10,000 became $25,468 or 35% less)
5. Firm ownership structure 6. Consistency of portfolio returns with the
investment process (attribution reports)
6. Manager compensation and incentives
structure (salary, bonus, stocks, shares…) 7. Funds concentration
that reward individual contributions
8. Tracking Error and Active Share: these
7. High conviction approach that is distinct numbers represent how much the fund
and with potential to outperform. returns deviate from the benchmark
8. What percentage of research is generated 9. Beta and Correlation with the fund’s
internally (vs. sell-side research from Wall true Benchmark (R square)
Street)?
10. Inflows/Outflows and total assets in the
Such data may not available by directly fund today and 5 years ago
looking into sources like Bloomberg and
Morningstar. This requires contacting every 11. Up/Down capture ratio and maximum
fund and requesting them to provide the drawdown
data.
We also review the portfolio composition, 12. Sortino Ratio which measures the risk-
size (small or large cap) and style of the adjusted return
funds, manager concentration, and if a
manager has closed a fund to new investors 13. Volatility
in the past and ask how they decide to close 14. Turnover which measures the number
it in the future. of times securities/shares are
replaced/traded
10

11.
Performance May Lower your Returns
1. Dalbar Research Institute shows that investor’s performance does not equal investment
performance. They found the following annualized returns for investors from 1987 to 2006
(similar results are found for different time period):
-The average equity-fund investor realized an annualized return of 4.30% ($100,000
became $222,536).
-The market timer equity fund investor realized an annualized return of -1.80% ($100,000
became $70,814).
-The market (S&P 500) realized an annualized return of 11.80% ($100,000 became
$832,519).
2. Using another research report from Lipper and DALBAR, we can see, in the chart below,
that chasing performance may lower your returns. This research shows how mutual fund
investors’ behavior affects the returns they actually earn.
Source:
Lipper and
DALBAR
11

12.
your stone age brain may be good with
physical risk, but it is the same one that
Let's Put Things in governs your investment gut - it is not a
Perspective good investment manager.
As you know, we take a long-term, academic
and disciplined approach to investing and
We decided this time to send you some we try not to react emotionally to market
charts to help you put things in perspective swings, unlike many individual investors
since the U.S. stock market went down 8% who tend to sell equities and lock in losses
in July and August. Note that the market is during down-turns. The portfolios we
still up 5% in the last 12 months and up recommend are always customized and well-
70% since March 2009. diversified. Markets volatility and declines
give opportunity to rebalance the portfolios.
The charts attached may help you draw your
own conclusions without being manipulated
by the media, friends…
See the entire Newsletter at:
In Summary: Newsletter, September 2011
· This summer’s stock decline was
nothing exceptional
· The economy doesn’t look that bad
· Stocks are not expensive
Details
· Stocks perform well over the long-
term, sometimes right after a major
correction and/or spike in volatility •U.S. Stocks have been going up in the long
run and outperformed bonds most of the
time over any 5-year periods
We still think that the chance of another
recession may be 20% - 50% before 2014 •Historically stock market declines have
but the charts should help you to put in been much worse: down 86% in 1929-32,
perspective what happened this summer. 49% in 2001, 57% in 2007-09…
A huge part of successful investing is
just avoiding common errors like •Other asset classes have seen much worse
panicking. The goal is not to be error-free; decline:
it is to be right more than wrong over time. -Long U.S. Treasury Bond real return was
Humans are intuitive creatures, but markets negative 67% between 1941 and 1981.
are inherently counterintuitive. Investing, -Gold was down 62% between 1980 and
like medicine and many fields of science, 1986
is a probabilities game, not a certainties -Japan Stocks were down 82% between 1990
game. Investing requires faith that
and 2009
Capitalism is not perfect in the near term -Most declines have been followed by 5
but eventually gets very close longer term. years of gains
Sometimes, doing nothing is the best •Nearly every significant up year for the
strategy... and it is not easy... When you are markets had also a significant intra-year
tempted to go with your gut, remember that decline
12

13.
•When the volatility is high, markets often •When consumer sentiment bottoms, the
rise following 12 months tend to be good for
•U.S. Companies are in much better shape stocks. Extreme pessimism in consumer
(profits, cash holdings, dividend payouts) confidence may be a bullish sign for the
than in 2000 market
•The Yield curve is usually flat before •Moderate GDP Growth (2%-3%) has not
recessions. It is far from flat now been bad for stocks historically. But can we
keep a 2%+ growth?
•DIVERSIFICATION WORKS!
U.S. Stock Market History, 1871 – April 2011
Initial Job Claims Is Down: Usually, it is Up Before
Recession – (Recessions are in grey)
13

14.
Stocks Outperformed Bonds Most of 5-Year Periods
Historical Markets Declines: We Have Seen Much
Historical Markets Declines: We Have Seen Much
Please find
the first
BFM Video:
Video
You will find
investment
strategies to
help you
reach
financial
security,
grow your
assets and
achieve a
comfortable
retirement.
14

15.
Apendix
4. Think about Estate Planning: Look
Year-End Financial into how various trusts, such as a bypass
Planning Tips trust or grantor retained annuity trust, might
help you reduce your estate tax liability.
2010 YEAR-END FINANCIAL
PLANNING : What you should have done !
5. Accelerate or Defer deductions: Have
With the end of the year approaching, here your tax advisor determine now if you have
are some important tax and financial any Alternative Minimum Tax (AMT)
planning measure you can take to reduce liability for 2010. If so, you may consider
your taxes and improve your financial deferring taxable income to 2011 or
position. accelerating or deferring deductions in 2010
to minimize AMT.
1. Sell some stocks, bonds, or mutual
funds before the increase in capital and 6. Spend all your money in your FSA: Use
income tax rates: Look at carryovers of any balance in your employer’s Flexible
past tax losses and whether any potential Spending Account (FSA) for qualified
losses on depreciated securities would be medical expenses by year-end 2010. When
more valuable in 2010 or in future years. If estimating your contributions for next year,
you end up with a loss, either short or long consider the increasing costs of uncovered
term, $3,000 of that loss can be used to medical expenses and changes in your
offset ordinary income. A $3,000 loss will company’s medical insurance plan.
save you approximately $840 in taxes,
assuming you are in the 28% bracket. Short- 7. Take your Required Minimum
term capital gains (one year holding or less) Distribution (RMD) once you turn 70.5
are taxed at ordinary income tax rates up to years old (or you can be subject to a 50% tax
35% in 2010. Long-term capital gains (more penalty!)
than one year holding) are taxed at 15%, for
taxpayers in the 25% tax brackets or above.
Tax rates should increase in 2011.
8. Fund your 529 higher education savings
2. Contribute to your IRA and other plan ($13,000 per person, per beneficiary).
company retirement accounts: IRA - 401
(k) - 403 (b) accounts provide tax-deferred
9. Other Deductions: In 2010, did you buy
growth. Since January 2010, high-income
a new car or first house, upgrade your
investors also have the opportunity to
existing home to be more energy efficient,
convert assets from a Traditional IRA or
or pay for a dependent’s higher education
employer-sponsored retirement plan to a
expenses? You may meet the requirements
Roth IRA. A Roth IRA offers tax-free
for claiming a tax credit or deduction. You
income in retirement.
could also pay your property taxes by year
end if you are a home owner.
3. Make Donations: In 2010 you can gift
up to $13,000 ($26,000 for a married couple)
free of gift tax.
15

16.
About Bourbon Financial Management, LLC
Bourbon Financial Management was formed to provide our clients (starting with
ourselves) with an effective and comprehensive solution for managing their global wealth.
Our disciplined and rigorous approach comes from our collective knowledge in serving
large institutional clients over many years.
Our core investment belief is that asset allocation (equities, fixed income, cash, real estate…) is
the single most important determinant of success in any investment plan. The dominant amount
of risk and return comes not from your choice of individual investments but from your asset
class mix. Bourbon Financial Management focuses our resources on risk management and asset
allocation.
Patrick Bourbon, CFA
PLEASE SHARE OUR NEWSLETTER: Our newsletter readership is not limited to our
clients. Please tell those you feel may be interested that they can subscribe to their own free copy
of the newsletter at info@bourbonfm.com. Thank you.
BOURBON FINANCIAL MANAGEMENT
Excellence ~ Experience ~ Ethics
616 W. Fulton St., Suite 411, Chicago, IL 60661
+1 312-909-6539 ~ www.bourbonfm.com
Member of the Financial Planning Association and Academic Affiliate of the National
Association of Personal Financial Advisors.
© 2012 Bourbon Financial Management, LLC ~ All Rights Reserved ~ Info@bourbonfm.com ~ (+1) 312 909 6539
16