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(Why) You Suck at Investing

Posted By Barry Ritholtz On March 27, 2005 @ 7:03 am In Apprenticed Investor,Investing,Psychology,Rules | Comments Disabled

Usat [1]

USA Today had an interesting article this past week (it happens). The discussion was on the fact that Most Americans no good at investing [2].

A more accurate title would have been "Humans not good at investing." There’s a very specific reason for this; It is something I am in the middle of writing up, and will address very soon in print.

Meanwhile, here’s an excerpt:

"A study by Hewitt Associates that analyzed the 2003 investment behavior and account activity of 2.5 million employees eligible for 401(k) plans exposes a trove of investment mistakes by average investors:

• Three out of 10 employees eligible for 401(k) plans don’t participate, Hewitt says. That means investors are passing up free money in the form of matching contributions from their employers.

• Despite horror stories about employees at scandal-scarred companies such as WorldCom and Enron having their 401(k) accounts wiped out because they had all their money riding on their own company’s stock, 27% of 401(k) investors still have more than half of their money in their employer’s shares.

• And proving that investors are hardly hands-on, only 17% made 401(k) transfers in 2003.

Another Hewitt study, done in fall 2004 with Harvard University and the Wharton School at the University of Pennsylvania, found that a "non-saving mentality" persists. The study focused largely on "low savers," those who do not stash enough in their 401(k)s to earn the company match. When "low savers" learned they were passing up $1,200 a year in matching contributions, one-third said they intended to raise their savings rate. Only 15% actually did."

This factor, more than any other reason, explains why the President’s Social Security Privitization idea has generated so little positive response amongst most Americans.


UPDATE  March 27, 2005 9:12 am

Put aside the Social Security issue for a moment. I find the argument that people are not hard wired to be investors is quite fascinating. Wall Street uses a variation of this to suggest "professional management;" indexers use it to argue against active management; discount brokers say if you can do as well as the mediocre pros, then why pay big commissions?

All of these positions miss the bigger picture: Why are Humans Beings so ill suited to investing?

I first came across one of my favorite explanations as to why we simply aren’t hardwired to undertake risk reward analysis in capital markets many years ago; It was from Michael Mauboussin , now Legg Mason Funds chief investment strategist, formerly chief U.S. investment strategist at Credit Suisse First Boston. In a cogent and persuasive manner, Mauboussin explains [3] the reason why: "the mind is better suited for “hunting and gathering” than it is for understanding Bayesian analysis."

Simply put, you just ain’t built for it. Mauboussin breaks down the emotional and psychological impediments into 7 subtopics:   

· Desire to be part of the crowd.
· Overconfidence.
· Inability to assess probabilities rationally.
· We love a story, especially when it links cause to effect.
· Use of heuristics, or rules of thumb.
· Chance.
· Fitness landscapes and the role of the inductive process.

Each of these are explained in more detail, but the bottom line remains: Most people simply do not posses the counter-intuitive skillset, or the emotional detachment, or the discipline required for long term outperformance in the markets . . .


Been round here long . . . ?


Capital markets have not been around all that long (relatively speaking).


Most Americans no good at investing [2]
Adam Shell
USA TODAY, Posted 3/23/2005 12:12 AM
Updated 3/23/2005 1:14 PM

What Have You Learned in the Past 2 Seconds? [3]
Michael Mauboussin
March 12, 1997

Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2005/03/why-you-suck-at-investing/

URLs in this post:

[1] Image: http://www.usatoday.com/

[2] Most Americans no good at investing: http://www.usatoday.com/money/perfi/general/2005-03-23-investing-cover_x.htm

[3] explains: http://www.capatcolumbia.com/Articles/FoFinance/Fof2.pdf

[4] Image: http://www.ritholtz.com/blog/wp-content/uploads/2005/03/homo_sapiens_1.jpg

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