What kind of investor do you think you are? Do you try to time the market and jump in at the right minute? Or are you a more cautious kind of person who spends hours researching market performance before you consider buying or selling anything?
In fact, it doesn’t really matter what kind of investor you think you are. The results of your efforts are translated into the profits and losses that appear in your portfolio. Therefore, even if you feel very confident and have a great feeling about a particular stock that everyone’s talking about, when push comes to shove, your emotions make very little difference. Actual market performance is, at the end of the day, what counts.
For many years, investors have always wanted to know what the true secret is to buying the right stocks. From the South Sea Bubble to the Great Depression, there are those who fell by the wayside when everything went wrong, while on the other hand, there were those who made the right moves and ended up living in luxury. So, what is it that helps some people get it right, while others don’t? Is there any real basis for investing by following your gut feelings? And, if the famous disclaimer, “past performance is no indication of future returns,” is actually true, what is the point of all of the research out there into markets, stocks, performance, etc. anyway? Perhaps the whole thing is one great gamble.
These questions, of why people invest the way they do, have occupied researchers in recent years, giving rise to the science of behavioral investing. One such researcher, Professor Terrance Odean of the University of California (Berkeley), studied the behavior of investors and reached the conclusion that “the average investor is his own worst enemy.”
According to Professor Odean, “the average investor is better off not trying to time the market.” From his research, he has found that individuals tend to get market timing and behavior wrong more often than institutional investors. There can be many reasons for this. For example, an individual is more likely to be driven by emotions such as fear or regret, whereas an institution is less likely to be driven by emotion. Secondly, as Professor Odean points out, “there are times when institutional investors know things that individuals don’t know, so they have an informational advantage or ability to process publicly available information in a better way.”
Based on Professor Odean’s research, the most efficient way to buy stocks may be to use the services of a money manager. Professional money managers hopefully won’t be blinded by emotion when making investment decisions (after all it’s their job!) and have more access to the right information than the average investor.
If you want to find out more about the theories of behavioral investing, watch a video of my interview with Professor Odean, which took place on the Goldstein on Gelt radio show.