I manage my own portfolio, buying conservative stocks that pay a decent dividend.
It’s a philosophy that works for me. I’d rather earn income on boring bank and pipeline stocks than speculate on fast-growth stocks.
Apple Inc. is up almost 80 per cent in the past year, but its high-flying shares (at $358 U.S. apiece, they’re priced at 20 times earnings) scare the heck out of me.
Do you know what you want as an investor? Meir Statman, an expert in behavioural finance, wants to help you define your personality.
In a new book, What Investors Really Want (McGraw-Hill, $34.95), he looks at the many things you might want — everything from excitement to status to staying true to your values.
A finance professor at Santa Clara University in California, he thinks that rational investors don’t exist.
You and I — and even wealthy and famous people, such as Martha Stewart — are all normal investors. We’re not stupid, but neither are we rational.
We’re reluctant to realize losses, so we hold onto stocks long after the point when we should have sold them.
Stewart, a caterer who built a large fortune, sold shares of ImClone Systems after being tipped off that company executives were dumping their shares. She went to jail for five months for insider trading.
Evidence presented at Stewart’s trial showed she was reluctant to sell stocks and realize losses that existed only on paper. It made her stomach turn.
“If Martha Stewart were rational, she would have felt her stomach turn when the prices of her stocks declined and she incurred her paper losses,” Statman writes.
“That is when her wealth decreased. But she would have rejoiced when she realized her losses, since the tax benefits of realized losses added to her wealth.”
Normal investors sell our winners too early and ride our losers too long because we’re not rational.
We make cognitive errors and we fall sway to our emotions, such as pride, regret and lack of self-control.
I first heard of Statman’s book when it popped up on a few blogs I follow, such as Canadian Capitalist and Canadian Dream: Free at 45.
The author had done a tour of the finance and investing blogosphere, offering exclusive content to those who wished to host him. What a great way to build a buzz.
Interviewed last week before flying to Tilburg University in the Netherlands, where he’s a visiting professor, the Israel-born Statman told me he’d studied investor behaviour since 1980.
“I want to help people look at themselves, as in a mirror, to figure out what they really want and how to go about getting what they really want,” he said.
Profit is the first thing most people say when asked why they invest. But if that were the case, they’d buy a diversified portfolio of index funds or exchange-traded funds that guarantee market returns.
But many of us think we can beat the market, so we buy actively managed mutual funds and individual stocks.
“It’s fun to play around,” Statman says, quoting U.S. investment dealer Charles Schwab, “People love doing that. They love to find winners.
“It’s human nature to try to select the right horse. It’s fun. There’s much more sport to it than just buying an index fund.”
Institutional investors are no less eager to play the game — and they aren’t much better at beating the market than individual investors, he notes.
Status is also an emotional benefit of investing. You might be lucky enough to get into an arrangement available only to a few, such as Goldman Sachs’ Facebook deal.
Hedge funds, sold only to sophisticated investors with a high net worth, make it easy to brag about your riches without appearing to brag.
Sometimes, the rich subvert the emblems of status, Statman says, pointing to Henry Paulson, a former U.S. treasury secretary and Goldman Sachs partner, who wore a cheap Casio watch.
Investors in low-cost index funds often wear their funds as the equivalent of Casio watches. They’re saying, “I’m too smart to pay extra for funds that are likely to deliver lower returns than index funds.”
As an index investor himself, Statman doesn’t condemn anyone who prefers picking stocks and actively managed funds.
He uses cars as an analogy. You buy a Honda Accord, but your neighbour buys an Acura – a more expensive luxury car from the same maker.
“You don’t say your neighbour is an idiot, but his tastes differ from yours. He likes action and pizzazz and he’s willing to pay more for that.”
Classic finance has rational people in it, but rational people don’t exist. Behavioural finance has normal people in it — sometimes smart and sometimes stupid.
“I thought I had something to say to regular investors and I wrote the book in a way that’s not condescending,” Statman says.
“I hope you can see my smile as you’re reading the chapters.”
I enjoyed this rich compilation of behavioural quirks, which can help you recognize yourself and make better investing decisions.
Ellen Roseman
Toronto Star
02/20.2011
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