Hard to Fire Yourself; Easy to Fire Your Manager

////Hard to Fire Yourself; Easy to Fire Your Manager

Hard to Fire Yourself; Easy to Fire Your Manager

By |2017-08-18T17:03:59+00:00December 18th, 2014|Research Insights, Behavioral Finance|3 Comments

Looking for Someone to Blame: Delegation, Cognitive Dissonance, and the Disposition Effect


We analyze brokerage data and an experiment to test a cognitive-dissonance based theory of trading: investors avoid realizing losses because they dislike admitting that past purchases were mistakes, but delegation reverses this effect by allowing the investor to blame the manager instead. Using individual trading data, we show that the disposition effect — the propensity to realize past gains more than past losses — applies only to non-delegated assets like individual stocks; delegated assets, like mutual funds, exhibit a robust reverse-disposition effect. In an experiment, we show increasing investors’ cognitive dissonance results in both a larger disposition effect in stocks and also a larger reverse-disposition effect in funds. Additionally, increasing the salience of delegation increases the reverse-disposition effect in funds. Cognitive dissonance provides a unified explanation for apparently contradictory investor behavior across asset classes and has implications for personal investment decisions, mutual-fund management, and intermediation.

Disposition Effect in Stocks:

This paper reinterprets a well know behavioral bias, the “Disposition Effect”, which depicts investors’ greater propensity to sell assets at a gain than at a loss. We describe the disposition effect in “Sell Winners Too Early and Hold Losers Too Long.”

The authors first highlight a psychological explanation that helps investors understand such reluctance to realize losses: People will experience discomfort or psychological pain when encountering new information which contradicts their existing beliefs.

To be specific, an investor who has created the self-image of being a good decision-maker does not like to admit that he is wrong. Thus, he will be reluctant to realize losses when investment performance is bad, which leads to the “disposition effect.” He wants to reduce the mental costs of admitting mistakes or at least delay such pain.

Reverse-Disposition Effect in Funds:

This paper also finds that the disposition effect is reversed in the case of delegated assets, such as in mutual funds. That is, investors have a greater propensity to sell losing funds compared to winning funds. This behavior is consistent with behavioral psychology: when fund performance is bad, investors tend to blame fund managers and sell the related assets as a consequence. By blaming a scapegoat, investors feel mitigation of pain associated with losses, while still maintaining a positive self-image. 

 Key Findings:

1. Paper run regressions (see Part II) with several dummy variables to test for the disposition effect. Data include 128,829 accounts from 1991 to 1996.

  • Results (Table II and III) confirm the hypothesis: the disposition effect in stocks and the reverse-disposition effect in actively managed funds holds for the same investors at the same time.

2. It is worth mentioning that the paper designs two experiments to provide direct evidence of cognitive dissonance as a cause of the disposition effect. 520 undergraduates participated in their online trading experiments, which lasted over 12 weeks. Each student was given an initial endowment of $100,000 and randomly assigned to trade either stocks or mutual funds. There were two treatments:

  • “Story” treatment: This treatment is designed to increase cognitive dissonance. All students have to present a reason for their buy decisions and they are reminded frequently about their stated reasons during the experiments, especially when they move to sell the asset.
  • “Fire” treatment: This treatment is designed to increase the salience of the fund manager. Students are provided with choices of “Hire”, “Fire”, and “Fund Manger’s performance/gain/loss” rather than “Buy”, “Sell” and “Portfolio performance/gain/loss”. In addition, students in the fire treatment are provided with a fund managers’ bios.

2014-11-11 11_05_02-Looking for someone to blame.pdf - Adobe Reader

2014-11-11 11_06_20-Looking for someone to blame.pdf - Adobe Reader

The experiment’s results can be found from Table VI.

  • The higher the level of cognitive dissonance, the larger the disposition effect in non-delegated assets (stocks) and the larger the reverse-disposition effect in delegated assets (funds).
  • The bigger the effect of delegation, the bigger the reverse-disposition effect. In other words, if investors focus more on the role of the fund manager instead of their own role, they feel mitigation of pain associated with realizing losses.

  • The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. Our full disclosures are available here. Definitions of common statistics used in our analysis are available here (towards the bottom).
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About the Author:

After serving as a Captain in the United States Marine Corps, Dr. Gray earned a PhD, and worked as a finance professor at Drexel University. Dr. Gray’s interest in bridging the research gap between academia and industry led him to found Alpha Architect, an asset management that delivers affordable active exposures for tax-sensitive investors. Dr. Gray has published four books and a number of academic articles. Wes is a regular contributor to multiple industry outlets, to include the following: Wall Street Journal, Forbes, ETF.com, and the CFA Institute. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.


  1. Michael Milburn December 19, 2014 at 2:51 am

    Wes, do you think “consideration” plays a part in this effect? The study seems to force the player to watch what’s going on fairly regularly and make repeated decisions. I wonder if simply reducing opportunities for consideration might be helpful.

    I say this, because I find that after a certain point on my long term holdings, I just don’t pay that much attention to stocks that are in the green that I’ve held for a few years and generally like the business. I don’t give winners that much consideration for sale because I’m up – and the psychological impact of being able to wait out volatility seems easy to take. Behaviorally, I find not thinking about a sell price so much makes holding winners easy – and I try to only consider sale when the price surprises me w/ a high valuation. I am more wary of cyclicals, so I put them in a special category, but the general rule holds. I guess it’s my way of simply letting winners run by not thinking about them too much.

    In contrast, I watch my losers like crazy as I’ve found they hold the greatest risk for me. I have a tendency to think a negative price move is just volatility when often there’s more information there than I aware of. I tend to believe that often a stock going down has a reason for going down (vs. prior thinking when I was younger that it just became a better buy). I now use stops and prohibit myself from averaging down after some really bad trade experiences. (I’ve talked to other investors who are perfectly happy averaging down, but I have to stay away from the practice.) I find I’ll sometimes sell a short term loser that I should’ve just held – I’m not sure if the net effect is beneficial or not (recent examples where I should’ve held are PETM or DE; probably my most regretful was CHRW after discouraging conference call right before things turned; and a current example of bad behavior is VMI) – but by doing this I’ve also avoided most of the huge kick-in-the-gut losses since I’ve set rules of this nature. It seems most of the kick-in-the-gut losers have looming bad news that tends to show up in the price charts before it’s disclosed, and something about my selection process may make stocks I select more susceptible.

    I guess the hardest thing to do (at least now in my investing life) is hold a loser. They bother me and take up mental space. Paul Tudor Jones said something in the Market Wizards book that stuck with me – along the lines of sell a loser and get flat so you can think clearly. You can always reenter, but the simple act of getting flat changes your perspective.

    • Wesley Gray, PhD December 19, 2014 at 9:35 am

      If you reduce activity, you often improve performance on an after-cost, after-tax basis. If we take a simple world where everything is 100% random, but we have fees for transactions, and tax consequences when we sell, clearly, NOT DOING ANYTHING is a better bet than doing something.

      I don’t think the world is completely random, but it is a close. And fees and taxes are huge bites out of the investment pie. In the end, “trying too hard” in financial markets is dangerous to one’s health: http://www.alphaarchitect.com/blog/2014/05/13/white-paper-trying-hard/

      Your rule-driven approach to the markets, informed with psychology research, is the way to go. Keep it up!

    • Jack Vogel, PhD December 19, 2014 at 11:18 am

      Here is a related paper which discusses how often an investor evaluates his/her portfolio, and how it affects the disposition effect. https://www.princeton.edu/~wxiong/papers/disposition.pdf

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