WHAT INVESTORS REALLY WANT Discover What Drives Investor Behavior and Make Smarter Financial Decisions
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WHAT INVESTORS REALLY WANT Discover What Drives Investor Behavior and Make Smarter Financial Decisions MEIR STATMAN New York Chicago San Francisco Lisbon London Madrid Mexico City Milan New Delhi San Juan Seoul Singapore Sydney Toronto Copyright © 2011 by Meir Statman. All rights reserved. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a database or retrieval system, without the prior written permission of the publisher. ISBN: 978-0-07-174166-8 MHID: 0-07-174166-6 The material in this eBook also appears in the print version of this title: ISBN: 978-0-07-174165-1, MHID: 0-07-174165-8. All trademarks are trademarks of their respective owners. Rather than put a trademark symbol after every occurrence of a trademarked name, we use names in an editorial fashion only, and to the benefi t of the trademark owner, with no intention of infringement of the trademark. 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Under no circumstances shall McGraw-Hill and/or its licensors be liable for any indirect, incidental, special, punitive, consequential or similar damages that result from the use of or inability to use the work, even if any of them has been advised of the possibility of such damages. This limitation of liability shall apply to any claim or cause whatsoever whether such claim or cause arises in contract, tort or otherwise. To the memory of my beloved parents, Tova and Mordechai Statman This page intentionally left blank Contents INTRODUCTION: What We Want ix We want more than high profi ts from our investments. We want to be number 1 and beat the market. We want to nurture hope for riches and banish fear of poverty. We want to feel the pride of profi ts and avoid the regret of losses. We want the sophistication of hedge funds and the virtue of socially responsible funds. And we want to leave a legacy for our children. CHAPTER 1: We Want Profi ts Higher than Risks 1 Investments with profi ts equal to their risks are as easy to fi nd as good lunches at fair prices. But we want free lunches, not fair ones, and we are always searching for investments with profi ts higher than risks. CHAPTER 2: We Have Thoughts, Some Erroneous 17 Cognitive errors mislead us into thinking that investments with profi ts higher than risks are easy to fi nd. Hindsight errors are one example, misleading us into thinking that we have seen investment winners in foresight when, in truth, we have seen them only in hindsight. CHAPTER 3: We Have Emotions, Some Misleading 37 Emotions, like cognitive errors, draw us into promises of profi ts higher than risks. Exuberance highlights profi ts and obscures risks; fear highlights risks and obscures profi ts; and unrealistic optimism exaggerates our investment skills and chances. CHAPTER 4: We Want to Play, and Win 55 Th e game of fi nding investments with profi ts higher than risks is tempting, even when we know that it is diffi cult to win. Playing the game makes us feel alive, in the groove, in control, and in the fl ow. And winning is exhilarating. v vi Contents CHAPTER 5: We Join Herds and Infl ate Bubbles 67 We stampede into investments in exuberance and stampede out in fear. We infl ate bubbles and defl ate them. Our herding instinct also opens the door to frauds, where early fools pull in late fools, and all turn into losers. CHAPTER 6: We Want Self-Control and Mental Accounts 81 We do not spend dollars from “hard-earned” mental accounts as easily as we spend dollars won in lotteries. Mental accounting facilitates self-control, stopping us from buying a shiny new car today when we need the money for retirement tomorrow. CHAPTER 7: We Want to Save for Tomorrow and Spend It Today 93 We try to strike a balance between saving too little and saving too much. Mental accounting helps us distinguish what we are permitted to spend from what we must save. Self-control helps us manage our confl icting desires to spend and save. CHAPTER 8: We Want Hope for Riches and Freedom from the Fear of Poverty 107 Investors who hate risk buy insurance policies, while investors who love risk buy lottery tickets. Yet most of us buy both, just as we buy both safe bonds and risky stocks. We are motivated by our twin desires of hope for riches and freedom from the fear of poverty. CHAPTER 9: We Have Similar Wants and Diff erent Ones 119 Some investors are passionate about hope, while others care more about freedom from fear. Our personalities, life experiences, and cultures weigh on the balance we strike between hope and freedom from fear. Contents vii CHAPTER 10: We Want to Face No Losses 133 Profi ts bring pride while losses infl ict regret. Realizing losses is especially painful because we give up hope of recouping our losses. So we realize gains quickly and procrastinate in the realization of losses. CHAPTER 11: We Want to Pay No Taxes 151 Some investors greet taxes with acceptance or resignation. Some feel smart and savvy when they avoid taxes. Some are angry that taxes are wasted by politicians. And some are willing to forego $5,000 in profi ts to avoid paying $4,000 in taxes. CHAPTER 12: We Want High Status and Proper Respect 161 Hedge funds open their doors only to the rich, making it easy to brag about riches without appearing to brag. Yet wealth does not always bring respect. Women investors resented disrespect a century ago, and they resent condescending attitudes today. CHAPTER 13: We Want to Stay True to Our Values 177 Some socially responsible investors are willing to sacrifi ce investment profi ts for human rights and others are willing to sacrifi ce profi ts for a clean environment. Values extend beyond social responsibility to religion, ideology, patriotism, and philanthropy. CHAPTER 14: We Want Fairness 195 We want to play on level playing fi elds in sports, investments, and every other fi eld. We boycott stores that treat their employees unfairly, protest unfair investment practices, and forego profi ts to avoid money managers whose fairness we suspect. viii Contents CHAPTER 15: We Want to Invest in Our Children and Families 209 We prod our children to do well in school and we save for their college expenses. Middle-class parents worry that they might not have enough for their children’s education. Rich parents worry that their children would feel entitled to spend what they do not earn. CHAPTER 16: We Want Education, Advice, and Protection 223 We are increasingly responsible for our fi nancial futures. We seek information, protection, and advice from fi nancial advisors, the Internet, the government, and other investors. Some advice is good and some is bad. Some sticks with us and some washes away. CONCLUSION: What We Have 237 Some trade investments because they have a true advantage over other traders. Others trade investments because cognitive errors mislead them.