What Do Investors Really Want?
And what do they really need? Distinguish between the two to balance their investment benefits.
December 6, 2010
We want more from our investments than profits equal to risks. We want to nurture hope for riches and banish fear of poverty. We want to win, be #1, and beat the market. We want to feel pride when our investments bring gains and avoid regret when they inflict losses. We want the status conveyed by hedge funds, the virtue conveyed by socially responsible funds, and the patriotism conveyed by investing in our own country. We want financial markets to be fair but we search for an edge that would let us win. We want to leave a legacy for our children when we are gone. And we want to leave nothing for the tax man.
Investments as Movies
Have you noticed that most movies are fiction? Of course you have. You know that the people you see on the movie screen are actors, only pretending to be who they are not. You know that the movements you see on the screen are cognitive errors, optical illusions caused by fast projection of still images. And sometimes you wear funny glasses that fool you into seeing 3-D images on a flat screen. So why are we willing to pay money for movie tickets, sacrificing wealth for fiction and truth for exploitation of cognitive errors? The answer is obvious. Movies touch our emotions and add to our well-being. They make us laugh and cry and help us enjoy the company of dates, spouses, children and friends. Indeed, we enjoy movies more when we share expressions and emotions with our companions.
The world of investments is different from the world of the movies because it offers no clear boundary between fact and fiction. Lights are rarely turned on in the world of investments, so it is hard to distinguish fact from fiction and truth from cognitive errors. But the world of investments is also similar to the world of the movies because movies offer benefits that go beyond the benefits of facts, and investments offer benefits that go beyond the benefits of wealth.
Utilitarian, Expressive and Emotional
Investments offer three kinds of benefits: utilitarian, expressive and emotional. Utilitarian benefits are the answer to the question, "What does it do for me and my pocketbook?" The utilitarian benefits of watches include time telling, the utilitarian benefits of restaurants include nutritious calories, and the utilitarian benefits of investments are mostly wealth, enhanced by high investment returns.
Expressive benefits convey to us and to others our values, tastes and status. They answer the question, "What does it say about me to others and to me?" Private banking expresses status and esteem. One private bank advertised its services along with a chauffeured vintage Rolls-Royce and the tag line “Once you’ve earned exclusive service, there’s no turning back.” A stock picker says, “I am smart, able to pick winning stocks.” An options trader says, “I’m sophisticated, willing to take risk and knowing how to control it.”
Emotional benefits are the answer to the question, "How does it make me feel?" The best tables at prestigious restaurants make us feel proud, insurance policies make us feel safe, lottery tickets and speculative stocks give us hope, and stock trading is exciting. Gerald Tsai, Jr. was a fund manager who pioneered the go-go performance funds in the 1960s. “He loved doing transactions,” said Christopher Tsai, recalling his father’s enthusiasm about the stock market. “He loved the excitement of it.”
What We Want and What We Should
We are not embarrassed to admit that we want our investments to support us during our years in retirement. Neither are we embarrassed to admit that we want our investments to support our children or favorite charities. But some of what we want from our investments is embarrassing, such as our wanting status. We might want to mention our investments in hedge funds, knowing that hedge funds signal high status because they are available only to the wealthy. But a loud expression of status, like a loud display of an oversized logo on a Gucci bag, can bring embarrassment rather than an acknowledgment of status.
“Wants” are also difficult to acknowledge because they often conflict with “shoulds.” The voice of wants says, “I want this new red sports car,” but the voice of shoulds says, “You should buy a used sedan and add the difference in price to your retirement account.” Investment advice is full of shoulds: save more, spend less, diversify, buy-and-hold. Wants are visceral while shoulds are reasoned. Wants often drive us into stupid investment choices, while shoulds drive us mostly into smart ones.
Indulgence, impulsive spending, and lack of self-control are the norm, testifying to the tempting voice of wants and evident in the mountains of debt we accumulate. But we can go too far in restraining indulgence and tightening self-control. Spendthrifts would do better with a little less indulgence, but tightwads would do better with a little more. The reasoned voice encourages well-off tightwads to splurge on a great dinner at a fine restaurant. They can surely afford that dinner without hampering their retirement prospects. But the visceral voice dissuades tightwads from enjoying their meal, as their thoughts drift to the pain of the restaurant tab. Years later spendthrifts regret excessive indulgence and insufficient self-control, while tightwads regret insufficient indulgence and excessive self-control. One financial advisor told me of a tightwad client who lived in a dilapidated house and deprived his family of necessities only to leave them $3 million when he died.
CPA planners can help investors find a good balance between the utilitarian, expressive, and emotional benefits of investing. CPA planners cannot prohibit trading by investors who derive expressive and emotional benefits from it, but CPA planners can guide investors away from trading that fritters away money they will need for their retirement income and the education of their children.
Meir Statman is the Glenn Klimek Professor of Finance at the Leavey School of Business, at Santa Clara University. His research on behavioral finance has been supported by the National Science Foundation, CFA Institute, and Investment Management Consultants Association (IMCA) and has been widely published in national publications. His most recent book entitled “What Investors Really Want” is available at Amazon.com.
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