At this time of acute uncertainty and high anxiety, how do investors behave? Some worry and trade; some worry and do nothing. Either behavior is entirely normal, behavioral finance pioneer Meir Statman argues in an interview with ThinkAdvisor.
This is not to say that the Santa Clara University finance professor condones excessive trading. In fact, if he could “put handcuffs” on David Portnoy, the so-called “poster child of the day-trading craze,” he would, so to speak.
Nonetheless, Statman contends it’s not individuals that are driving the market but professional institutional investors — those folks along with, seemingly, the coronavirus itself.
The behavioral finance authority, consultant to a number of investment companies, came to prominence with his 2010 book, “What Investors Really Want.” His two most recent tomes are “Finance for Normal People: How Investors and Markets Behave” and “Behavioral Finance: The Second Generation.”
From his observations over the past months, Statman sees two predominant behavioral finance biases tripping up investors during the pandemic: “framing” and “representativeness.” In the interview, he discusses both.
The professor also talks about science’s method in trying to wrestle down the virus, a new one causing a new disease never before diagnosed.
Statman, who has just completed conducting an online investment course, including a section on options and futures, is the recipient of numerous prestigious awards, including three Graham and Dodd Awards and a Moskowitz Prize for best paper on socially responsible investing.
ThinkAdvisor interviewed Statman on June 19. He was speaking by phone from his home in Silicon Valley. As for actionable advice for financial advisors, he stressed that FAs need to bring up and hash out contingencies with clients, not assure them that everything will be all right.
Here are highlights of our conversation:
THINKADVISOR: Some people liken the current market to a casino because, they say, the Federal Reserve is encouraging risk-taking with low interest rates and stimulus. Do you see the heavy trading as normal behavior or irrational behavior?
MEIR STATMAN: It’s perfectly normal. This is a time of greater uncertainty. People are trying to figure things out. They don’t know when fear is going to abate or go deeper. So it’s normal for some to worry and trade, and it’s normal for others to worry and sit still and do nothing.
What do you think of David Portnoy, founder of Barstool Sports, who touts day-trading and brags of his success? He’s been called “the poster child of the day-trading craze.” Is he a bad influence?
He’s an absolutely bad influence. If I could just put handcuffs on him. I think he has some $3 million invested, which is peanuts relative to what a Fidelity or a Goldman Sachs invests. Lots of small investors get themselves into deep trouble because they don’t know what they’re doing, but they think they know more than they actually do.
Is that normal, too?
We all [sometimes] find ourselves in a situation where we have to realize that our confidence and our wisdom aren’t in perfect alignment. My high school math teacher used to call it “the confidence of the ignorant.”
What’s an example?
Look at that 20-year-old college student who was trading options on [online BD] Robinhood. He thought his account showed that he had a cash balance of about minus-$750,000, and he killed himself. [It’s unclear why that figure was generated. He reportedly had $16,000 in his account.]
What are your thoughts about day-traders, in general — mostly young people who, many hold, are driving the market?
I don’t think the small investor is the tail that’s wagging the dog. Overall, their volume is small relative to the volume of professionals — institutional investors and so on. If you look at 401(k) accounts, most individuals have done nothing.
Does that help them?
If you don’t know what to do in the market, the best thing is not to do anything at all.
If individuals don’t do anything, no one will come to them saying, “Hey, what are you doing for me now?” But [institutional investors] feel they have to do something for their clients. Usually when people have to do something, they do stupid things.
On its website, Robinhood says: “Our goal is to make investing more affordable, more intuitive and more fun.” Should investing be intuitive? They also say: “Be bullish on stocks you invest in and bearish on the ones you don’t. It’s your call.” All that makes investing sound so easy, doesn’t it?
If you give people the sense that stocks and options are easy and that you can simply use rules to figure out when the market is going up or down, lots of people will think that it is so. They’ll think it’s a game in which everyone has the same chance, like a lottery. But of course the people who make money are the Robinhoods. They tell you that they’re doing it to help you, but Las Vegas wasn’t built on [casino] winners.
Do you see any classic behavioral finance biases that are messing up investors now?
Yes. One [issue] is how people’s attitudes in investing reflect their political leanings: Republicans think everything is going to be fine, and they’re pretty optimistic; Democrats are [pretty] pessimistic. I don’t think there’s any wisdom in one or the other or that it’s a good idea to let your political leanings affect your investing. There are a a bunch of cognitive and emotional errors that come into this.
Framing, which occurs based on the way information is presented. Why do amateur investors trade? Because they frame it as the equivalent of playing tennis against a practice wall with no opponent, when in fact it’s tennis against an opponent on the other side of the net. When you trade, you’re not trading against “a wall.” You’re trading against somebody else — and one of you is going to be sorry. In every trade, there’s an idiot. If you don’t know who that is, you’re in trouble. So when people on Robinhood or elsewhere buy stocks because they think they’re likely to go up, I have to ask: “Who are the idiots on the other side?”
What other biases do you see?
People use a cognitive shortcut that turns into the error called representativeness — judging by similarity. They may [perceive a similarity to] the 2008-2009 crisis, when the market went down deep and came back quickly, like a V-shape. But we don’t know what comes next with [the coronavirus]. Will it be an “L” or a “W” recovery, or something else? I just read about minks in the Netherlands that got the virus from infected humans, then passed it back to [farmers]. If COVID-19 is being transmitted this way, it might be that we’re in deeper trouble than we thought.
Many states [more than half, on June 24] are reporting a coronavirus surge. It seems as if it’s the virus that’s in control. Your thoughts?
I can see that. Some people say that scientists flip their opinions from day to day. I say no because I know how science develops.
You carefully analyze the information you have and make a decision based on that. But then new facts emerge, and you change your mind. So I don’t think it’s a matter of politics to decide that Democrats are wearing masks because they’re not manly, or whatever. That’s absurd.
Do financial advisors need to work harder at this difficult time to understand and counsel their clients?
Yes. Advisors have to reach out and speak with them — not to assure them that everything is going to be fine, because you cannot promise what you cannot deliver. But they have to talk about contingencies. What is likely to be least helpful is to engage in trading strategies or rearranging your investments. If you sell, somebody buys; and one of you will turn out to be wrong. But you don’t know who it will be. That’s a zero-sum game.
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