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It’s Not Just the Return
Investors Have Many Needs, and Need to Know Them
Meir Statman, one of the pioneers in the study of behavioral finance, has been taking his ideas to academic audiences for decades. Now he’s used his wide knowledge of the field to write a book of advice, What Investors Really Want, that’s aimed at the ordinary investor.
“Today that’s the general public,” says Statman, the Business School’s Glenn Klimek Professor of Finance. “You can no longer count on retiring on a pension from your employer, so as employees have been thrown into 401Ks and IRAS, we’ve all become investors. This is really a book for everyone.”
A normal investor is “sometimes smart, sometimes stupid.”
Statman’s book, subtitled “Discover What Drives Investor Behavior and Make Smarter Financial Decisions,” was published earlier this year by McGraw-Hill. Its fundamental message to investors is that they’re probably not as rational as they think and need to take a hard look at their saving and investing with an understanding of what they really want.
“If you’re a normal investor,” he says, “you’re sometimes smart, sometimes stupid. Along the way you’ll make mistakes and be led by your emotions rather than pure reason.”
A purely rational investor, interested only in getting the best possible return, would invest in index funds, Statman says. Those funds, made up of companies that comprise a broad stock index, such as the Standard and Poor’s 500, consistently outperform managed funds, where investment advisors try to custom-pick stocks they think will outperform the market.
But isn’t the best return what everybody wants? Not at all, he says. If that were the case, index funds would account for far more than the 13 percent of the investment pool they now claim. He cites several examples of different investment objectives.
Some investors, including Santa Clara University, want their money to be used in a socially responsible way. They shun the stocks of companies involved in tobacco, alcohol, gambling and other perceived evils. Other investors love the thrill of the trade, and are willing to accept a lower return in exchange for the fun of playing the investment game and scoring an occasional big win. Still others are vehement about not paying taxes and will forgo a profit if it’s taxable.
“People want things that are different from simply a high return at a low risk.” Statman says. “Finance professionals often try to separate money from life. I say you can’t do that. Money is for living and enjoying life, so you have to ask what the money means to that investor.”
For the average person, setting aside part of a paycheck, the money is there to provide a safety net, some peace of mind. It’s for a comfortable retirement; for repairing the car if it has a major breakdown; for covering a medical expense that isn’t insured; for helping out the kids if they get in a tough spot. “This is why most people save, and it’s also why people buy lottery tickets. They dream of being able to do these things,” Statman says.
For a hedge-fund manager, who makes hundreds of millions a year and has no financial worries, the money is probably viewed in a different light.In that case,” Statman says, “the money is more likely to be used to satisfy emotional needs. For example, you might buy Picassos or other expensive works of art, enjoy them for a while, then donate them to a museum and perhaps get your name put on a wing. There would be the satisfaction of having experienced something special and having done some good for the world.”
His book is also somewhat unusual for the genre, Statman says, in that it devotes an entire chapter to the question of saving vs. spending — an issue that precedes investment — and to the psychology and motivations behind it. The chapter title, consistent with the theme or psychological paradox throughout the book, is “We Want to Save for Tomorrow and Spend It Today.” In it he talks about how to develop a system of mental accounting and self-control that allows a balance between saving enough and enjoying your money now.
Statman says a number of people have told him personally that the book has helped them see investment issues differently than they did before.“A lot of people have told me, for example, that the sections on herd behavior have made them see the question in a more complex light,” he says. “If you buy a washing machine that got a top rating from Consumer Reports, and a lot of other people do the same, you’re not stupid for being part of that herd.
“If, on the other hand, you joined the herd that invested in Bernie Madoff’s fund, that was a mistake. The critical questions in appraising herd behavior are what, and how good, is the information driving the herd, and what are the potential consequences of joining the wrong herd. If you look at it this way, you see that herd behavior can be good or bad, depending on the circumstances.”
What Investors Really Want has been well-received in reviews, with critics praising its use of stories, anecdotes and humor to make its points. “This book is about normal investors like you and me,” Statman writes in the introduction. “We are intelligent people, neither irrational nor insane. We are ‘normal smart’ at times and ‘normal stupid’ at other times. We do our best to increase the ratio of smart behavior to stupid behavior, but we do not have computers for brains and we want benefits computers cannot comprehend.”
Want to download your own PDF. copy of the Fall 2011 Issue of Minds@Work?
Fall 2011 Contents
The Depression's Other Face
The Truth's about Leadership
Technology and Retail
More Than Technology