I’m partway through What Investors Really Want, a brilliant new book by Meir Statman, Glenn Klimek Professor of Finance at the Leavey School of Business, Santa Clara University. In the book, Prof. Statman, an expert in the burgeoning field of behavioural finance, provides a framework for understanding the different motivations that investors have and the trade offs between them. I asked Prof. Statman for a short explanation of the concepts discussed at length in his book:

In your book, you point out that investors derive benefits from their portfolio other than mere utilitarian returns. Can you expand on what these benefits are?

The expressive and emotional benefits of a portfolio are many. For example, those who include in their portfolio derivatives express themselves as sophisticated. Those who pick stocks can express themselves as smarter than index-fund investors.

On the emotional side there is the pride of beating the market and the satisfaction in trading.

These emotional and expressive benefits of investments often detracts from utilitarian returns. But investors also derive enjoyment out of these benefits. How should investors balance the cost of these benefits against investment returns?

I think that investors should be aware of the costs and benefits and judge the tradeoff themselves. Is playing the game of beating the market enjoyable enough to justify the likely lag relative to the market? (Is hearing Placido Domingo in a concert hall worth the $100 price of the ticket?)

Even investors who are strictly seeking utilitarian benefits from their portfolio are often tempted by the emotional side. What can these investors do to keep their impulses in check?

Investors can keep their emotions from affecting their actions by setting rules – such as no trading. Or by appointing the spouse or advisor to prevent them from acting on emotions (as smokers who want to quit tell friends not to give them a cigarette even if they ask).

This article has 13 comments

  1. Sounds like an interesting book… I’m looking forward to a more comprehensive review 🙂 wink, wink. Then maybe I’ll make a trip to Chapters!

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  3. I can see where the right balance of more money vs. the emotional benefits would depend on portfolio size. An investor who has $5000 who uses a strategy likely to lag the index by 2% per year is only giving up $100 per year to gain the emotional benefits. Giving up $10,000 per year on a $500,000 portfolio makes a lot less sense.

  4. @Doctor Stock: I think this is a very interesting book. I would have purchased it if I hadn’t received a review copy. The book provides a structure for thinking about all the tradeoffs that investors make. I also like the copious amounts of references in the book. It should keep me busy reading for months.

    @Michael: It doesn’t make much sense to me either. But some investors may find it hard to give up the thrill of trading. Perhaps, a small, segregated trading account is the answer?

  5. Everybody is different. I don’t think the author can generalize all of us “stock pickers” with one broad brush. I would have to list the reasons for my preference for stock picking over index or mutual fund investing as:

    a. Control. I prefer to hold stocks with some sort of a dividend and a low P/E. I generally filter out businesses which are losing money or are highly valuated and don’t pay a dividend.
    b. Conscience. Although historical data shows that they are good performing businesses, I personally don’t want to profit from tobacco, weaponry and oil – so I sleep better at night if those aren’t in my portfolio.
    c. Fees. In conjunction with a & b, I don’t like that I’d have to pay exhorbitant fees for someone else to put me in stocks that I don’t want.

    I don’t know whether I’ve historically outperformed the overall market – probably not, due to the fact that I don’t own tobacco, weapons and oil. But I sleep better at night knowing that the stocks I own fulfill my own criteria. And because of that, I really don’t care how I perform relative to the overall market.

  6. @Phil: Actually, Prof. Statman’s point is not to dismiss out of hand the expressive and emotional benefits investors derive from the portfolio just because they are not utilitarian. Rather, his point is that investors should be aware of these benefits and any trade offs they are making. For you SRI is an important criterion. That’s a valid reason to structure a portfolio differently. I’m enjoying this book tremendously precisely for this reason. It helps me understand better the different motivations investors have — motivations I may not share personally.

  7. I believe Statman’s claims that investors gain emotional benefits from the way they invest and that these benefits have value. However, it is important to compare the value of these benefits against lost returns. Phil S. gave a good example of the non-financial benefits he gets from stock picking from a restricted universe of stocks. Where he goes off the rails in my opinion is in refusing to compare his results to an index. How can he decide on whether the emotional benefits are worth the cost without knowing the cost? I don’t want to just single out Phil here because he may actually have a better idea than most how he fares against a passive index approach.

  8. 1. I like this new approach; kudos to your innovativeness.

    2. Is it possible for Michael to ever comment on anything without revealing his religious ferver for indexing?

  9. Ah, yes. Dr. Dale is back to pointless personal insults. All is right with the world. I don’t suppose you have an opinion on whether it makes sense to measure returns? Or does money not matter?

  10. @Michael; Yes measuring returns is NB as is money. My point is that the index isn’t the “ONE AND ONLY” benchmark for some reasonable investors. (Think, for example, of SCIs or real estate investors).

    Know Michael that I generally like and laud your work.

  11. @Michael James. My portfolio is overweighted in financial services and real estate – my “core” assets, if you will. And then I dabble in everything else. I probably have more turnover in my portfolio than most of you, which makes it more difficult for me to track. For example, I bought TMX Group back in the summer near their 52-week low and just sold it this week for a 27% capital gain, plus I’ve received two dividend payments from them. Although it was always my intention to hold onto it as a “core” holding, I couldn’t resist the temptation to lock in the gain and put the cash in the bank until the next opportunity comes along.

    Unfortunately, my existing spreadsheet only calculates my returns based upon the stocks that I hold. It also doesn’t account for the dividends that I take from one stock and use to re-invest in another stock pick (I don’t use DRIPs – I prefer to use the dividends to buy different stocks, whatever I deem to be “cheap” when I feel like buying). And at times, I use leverage to juice up my returns when I find what I deem to be a “screaming bargain”.

    I would have to build in a LOT more sophistication into my tracking sheet to re-calculate the returns based upon the stocks that I’ve sold, where the dividends were reinvested and how & where I’ve used leverage. At the present time, I don’t see that as being a “value-added” use of my time, which is why I haven’t made the modifications.

    And that’s my super-long explanation why I don’t know where I stand relative to an index. My guess is that I’m probably in line with a 50/50 composite blend of the financials & real estate indexes.

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