Monday's Wall Street Journal includes the usual start-of-the-week supplement with an unusually provocative headline: The Mistakes We Make -- And Why We Make Them. In fact, the piece, by Meir Statman, a finance professor at Santa Clara University, is another of a seemingly endless number of attempts to apply behavioral finance to personal finance. For a newspaper supplement, Statman's little essay, which runs through 10 common mistakes small investors make, is entertaining in a breezy way, much as Freakonomics was a few years back. (Statman is an interesting name for a guy who studies emotions and behavior.) It's become the house style for behavioral economics. The problem is: There's not a single thing that Statman says, from checking your ego to not trying to out-time Goldman, Sachs & Co. (NYSE:GS), to "the future is not the past, and hindsight is not foresight" to the wisdom of dollar-cost averaging, that hasn't been advocated a million times over the past few decades in the non-behavioral personal finance media.
In short, the behavioral gloss is just that -- a gloss -- over "mistakes" that have long been identified as mistakes.
True, you can't repeat these old chestnuts too many times. But Statman isn't really revealing why we make the same old mistakes over and over again; thankfully, he doesn't reach for that cosmic explanation du jour, evolutionary biology, to explain why we can't seem to get investing right. The answer, however, is in front of everyone's nose, and it can't be argued away: As Statman admits, the future is not the past and that makes placing bets on a hoped-for future (say retirement) in a volatile market a continuing, probably eternal, challenge.
For example, the problem over the past few years was considerably deeper than dollar-cost averaging. Last fall and winter, investors large and small were confronted by a scary set of options. There were roughly two paths the economy could take: depression or recession. Although markets had already taken a serious tumble, selling out with your portfolio down, say 40 percent, was a rational option if a depression was looming. A depression, after all, might destroy equity values for a decade or more; and "destroy" is a lot more serious than "depress." Recession, on the other hand, would certainly knock equities down -- a serious problem if you're on the threshold of retirement -- but most investors would have the time to see at least some of that value returned.
Were we crazy to believe, or at least fear, that we were heading into a depression in December? Apparently, policymakers feared that possibility. The media was full of stories pounding home the return-of-the-great depression scenario. Some of the highest-profile economists in the world tossed the idea about regularly, possibly because they believed it, possibly because they knew an adequate policy response would come only if that particular bloody shirt was waved. OK, it's true; the economy (at least to this point) took the recession path and now seems headed toward some form of recovery. Investors who stayed the course have now seen a chunk of their portfolio values returned. Those who sold (depending on the timing of course) now look like they panicked; they made a "mistake."
The truth is behaving rationally in uncertain markets can't be done. Rational behavior depends upon some intelligent certainty about the direction markets and the larger economy will take, and when uncertainty is so radically profound, any decision is a shot in the dark and the line between rationality and lunacy gets fatally blurry. We should all adhere to Statman's guidelines, particularly in calmer markets where apocalyptic possibilities don't loom. But they don't help a hell of a lot when things get out of hand.
See Statman's column from The Wall Street Journal
Robert Teitelman is the editor in chief of The Deal.
This line really brought a smile to my face. But Robert, aren't you treating "rationality"as some sort of condition or state of mind that you either have or you don't? I would think it is more like a spectrum. Sure, we humans are in the end going to fall short of our ideals, but this shouldn't give us license to invest like lunatics, right?
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