|Forbes.com, Fall, 2013. This article was written with Jim Cahn, the Chief Investment Officer at Wealth Enhancement Group. It was part of a series of articles developed under an agreement with Forbes to work with a variety of contributors and assist them in delivering actionable investment ideas each week. The site forbes.com is one of the top 500 sites in the world with nearly 10 million subscribers and nearly 100 million page views a month.|
As human beings, we have a tendency to overestimate our own skills and predictions for success, or so say the behavioral psychologists. The behavioral finance experts have taken this concept several steps further to show that in the financial sphere, men are “more overconfident” and women are “less overconfident” and that temperamental difference directly affects their success in the market.
Central to the thesis of the seminal work on the subject is that men tend to be more overconfident – call it arrogance or whatever you like –and that contributes to “excessive” market trading. Following that, the increase in trading volume leads to lower returns.
Research indicates that the best way to identify an investor who will underperform the market is to find one who thinks he or she can outperform it, with the gender of the latter group overwhelmingly male which is underscored in the title of the groundbreaking Barber and Odean paper, Boys Will Be Boys: Gender, Overconfidence and Common Stock Investment.
What’s interesting to note is that researchers found no distinct performance advantage to being a woman. It was the consistent behavior exhibited – as they termed it “performance persistence” – that really mattered in generating steady returns.
While the research breaks these behaviors along gender lines, in my experience I see an analogy in comparing the ways individual investors invest compared to institutional investors. Furthermore, I think it may explain why institutional investors’ strategies so often outperform the individuals’.
So how do you go about “trading like a woman” aka investing in a “less overconfident” or perhaps “more institutional” manner? The simple way is to eliminate overconfidence and to emulate the behaviors exhibited by the majority of the women in the market. In short those behaviors are to trade less often, put emotion aside, weigh risk carefully and trade to invest — not ‘time’ — the market.
Women trade less frequently. Using account data for over 35,000 households from a large discount brokerage, Barber and Odean documented that men trade 45 percent more than women. Single men traded 67 percent more than single women.
Women turn their portfolios over approximately 53 percent annually, while men turn their portfolios over approximately 77 percent annually.
The key finding: Trading reduces men’s net returns by 2.65 percentage points a year as opposed to 1.72 percentage points for women.
Advice to trade less may sound counter intuitive when talking about investing. After all, taken to an extreme, it implies that never trading would yield the greatest benefit. Interestingly, Buffet has said he likes to buy stocks to hold “forever” so it’s not that far-fetched.
Put Ego Aside
Women are more rational investors. Ego, emotion and greed drive many investors to trade and, as the research has shown, the more you trade the more you destroy value.
According to the academics, men rely less on their brokers, believe that returns are more highly predictable, and anticipate higher possible returns than do women.
Many see a strong correlation between ego and insecurity. In fact, it’s the basis of a common sales tactic financial advisors use. When couples come into a meeting, an advisor talks primarily to the man, looking into his eyes, and then turns to the woman at the end to ask if she has any questions. The reason this sales tactic works is because it’s generally easier to influence a man, to play on his insecurity, ego and overconfidence.
Another way of looking at it, staying rational and not getting tripped up in your ego is the more profitable strategy.
According to the academics, rational investors only trade and only purchase information when doing so increases their expected utility (e.g., Grossman and Stiglitz ). Overconfident investors, on the other hand, lower their expected utility by trading too much; they hold unrealistic beliefs about how high their returns will be and how precisely these can be estimated; and they expend too many resources (e.g., time and money) on investment information.
Risk Aversion Is Fine
Women avoid risk. The academics’ models showed that women held less risky portfolios, while men tend to have riskier portfolios. I had this experience with a client the other day. He has a portfolio with just a few, highly concentrated stocks. He saw nothing wrong with this, largely because of his past experience. In his circumstance, he worked for a startup that went public and therefore had a great deal of that company’s stock and was not properly diversified vis a vis his financial goals.
Avoid Market Timing
Women do not try to time the market. The academics found that timing the market resulted investors buying securities that underperformed the ones they sold. After controlling for liquidity demands, tax-loss selling, rebalancing, and changes in risk aversion, the academics found that investors’ trying to time the market ended up in leaving them with a less valuable investment portfolio.
Women on average didn’t try to time the market, were not willing to trade on too little information and therefore they didn’t end up selling better securities and buying weaker ones.
I see this played out in the market all the time especially when the market is moving down which just happened in the recent rush to get out of emerging market stocks. People jumped in and unloaded perfectly good investments. Now they have not only effectively undiversified their portfolios they are not in position to take advantage of the market when it moves back up.
Anyone can trade like a woman. In fact, the fourth richest man in the world, the Oracle of Omaha, was said to consider the title of Louann Lofton’s book Warren Buffett Invests Like a Girl as a compliment.