Ask investors what they want from their investments, and most will say the answer is obvious: They want profits.
“Their answer may be obvious, but it probably isn’t true,” writes famed behavioral economist Meir Statman in a lengthy piece in The Wall Street Journal.
“Inside all of us are wants we don’t always express or [are] often even are aware of,” adds Statman, professor of finance at Santa Clara University author of “What Investors Really Want.” “When we make decisions about our money, we are often looking to satisfy those hidden emotional desires instead of doing what we say we’re doing—seeking out the best return possible.”
But not being aware of these hidden wants can lead us to make potentially devastating errors that can hurt us both emotionally and financially, he writes. Many people don’t understand them. Some mechanisms are available to help keep people on the straight and narrow.
“Payroll deductions to defined-contribution retirement savings plans such as 401(k)s aid self-control during our working years. We need not fight spending temptation since the money never passes through our hands. Later on, the prospect of penalties bolsters our self-control when we are tempted to withdraw money from our accounts before the age of 59½.”
Yet those protections aren’t perfect, and aren’t available to everyone, he notes. He argues that careful mental accounting is needed to bolster the self-control necessary to resist spending and promote savings during working years and control spending in retirement so we don’t run out of money before we run out of life.
“With mental accounting, we place wages, dividends and interest in “income” mental accounts and distinguish them from “capital” mental accounts that contain the stocks and bonds themselves. We feel free to spend income, but we prohibit ourselves from ever dipping into capital by selling stocks or bonds and spending the proceeds.”
In other words, we hope for riches and want protection from the fear of poverty
“These two related, but conflicting, impulses drive us in very different directions. Hope for riches urges us to invest our entire portfolio in a handful of 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 the internal conflict between these two desires by balancing our portfolios between mental accounts devoted to each one,” Statman concludes. “We commit errors when we let one want overwhelm the other.”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
