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A Few Notes on What Investors Really Want

November 16, 2010 • Posted in Animal Spirits, Individual Investing

Author Meir Statman states that his 2010 book What Investors Really Want “is about what we want from our investments. It is about how we think about our investments, how we feel about them, and how investment markets drive us crazy as we try to cajole them into giving us what we want… The sum of our wants and behaviors makes financial markets go up or down as we herd together or go our separate ways, sometimes inflating bubbles and at other times popping them.” Reflecting on “what we really want from our investments” with citations to a large body behavioral finance research, he concludes that:

We want:

Profits higher than risks: “…cognitive errors and emotions mislead many beat-the-market investors into the belief that investments with returns higher than risks are readily available when, in truth, they are not. …markets are beatable by some because they are not beatable by all.”

To play, and win: “We want pleasure from investing and speculating, and we want thrills from playing the beat-the-market game and winning it. Wall Street is…a poor place to look for thrills and Wall Street thrills remain expensive, but we are willing to pay the price. …Investing offers expressive and emotional benefits when practiced alone, but some investors find greater benefits when investing in communities.”

To join herds: “Investors everywhere run in herds, large or small, bullish or bearish. …Investors in herds give little credence to their own information and much credence to the information conveyed by the herd…even if, in truth, the herd’s information is useless or worse. …how can investors tell the difference between smart and stupid, distinguishing herds charging in the right direction from herds charging in the wrong one? Good judgment of information is one part of the answer. Good assessment of the consequences of a wrong choice is another.”

Self-control and mental accounts: “…mental accounting helps us face two major life challenges. One is the challenge of dividing our spending, saving and investing between the present and the future. …The other is the challenge of dividing today’s spending among all we want today. …its greatest benefit in our financial life is helping us balance our spending and saving over our lifetimes, so we do not live like kings when we are young only to live as paupers when we are old, and so we do not live like paupers when we are young only to leave a king’s fortune when we are gone.”

To save for tomorrow and spend it today: “The right dividend for us when we are young and saving for retirement is zero. Young investors who collect dividends might be tempted to spend them, and their self-control might not be strong enough to withstand temptation. The right dividend for us when we are older and retired is higher. We need this higher dividend to supplement income from pensions and Social Security.”

Hope for riches and freedom from the fear of poverty: “Hope for riches urges us to invest our entire portfolio in stocks and lottery tickets. Fear of poverty urges us to invest our entire portfolio in government bonds and hold tight to Social Security. …We resolve our internal conflict by dividing our portfolios into mental accounts, some devoted to hope for riches and other devoted to freedom from the fear of poverty. Self-control and control by others help us when we are tempted to dip into the wrong mental account.”

To face no losses: “Rational investors follow the maxim ‘Cut your losses and let your profits run.’ …Why are…the rest of us disposed to sell winners too early and ride losers too long? The answer to the puzzle is our cognitive errors of mental accounting and hindsight, our emotions of regret and pride, and our inner struggle for self-control. …We are pretty good at avoiding information about investment losses, sparing us the regret that accompanies facing them. …Losses make us angry, and anger propels us to take revenge by getting even.”

To pay no taxes: “We dislike taxes so much that we are willing to forego $5,000 to save $4,000 in taxes.”

High status and proper respect: “High returns bring wealth, and wealth elevates status. But hedge funds elevate status even when they detract from wealth. …While wealth is absolute, status is relative.”

To stay true to our values: “Socially responsible investors are prominent among those willing to sacrifice utilitarian benefits of investments for expressive and emotional ones.”

Fairness: “We want fair stock markets where our chances at winning depend on our skills, savvy or even luck, not ones where our chances are diminished by those who have fast computers and inside information. …we are willing to sacrifice utilitarian benefits for the expressive and emotional benefits of fairness. …Fairness is part of the social capital of a country, and social capital matters in financial markets because investors consider…the fairness of markets.”

To invest in our children and families: “We invest our money, energy, and hopes in our children… We derive expressive and emotional benefits from our investments in our children, proud of their accomplishments and comforted by their love. …Schools are much less effective than parents in teaching financial literacy and inculcating saving and investment habits in children.”

Education, advice and protection: “Our desire for paternalistic protection from ourselves and others increases when we experience the sad consequences of our own behavior or the behavior of others. Sometimes regulators are effective protectors. …Yet at other time regulators fail. …Good advisors possess knowledge of finance, as good physicians possess knowledge of medicine, and good advisors add to it the skills of good physicians: asking, listening, empathizing, educating, and prescribing. …Financial advisers frame themselves as investment managers, providers of ‘beat-the-market’ pills, when they are, in truth, mostly investor managers, professionals who examine the financial resources and goals of investors, diagnose deficiencies, and educate investors about financial health.”

Professor Statman closes by observing “…that investments are about life beyond money, and that we should enjoy all the benefits of investments–utilitarian, expressive, and emotional.”

In summary, What Investors Really Want is a broad survey of individual motivations for investing in addition to wealth-building. While the book might serve as guide for suppressing these other motivations (toward the end of maximizing wealth-building), its message seems more acceptance and enjoyment of some of these non-wealth payoffs.

While intended primarily for “normal” investors, the book may aid financial advisors in relating to such investors.

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