Guest Author: Meir Statman is Glenn Klimek Professor of Finance at Santa Clara University and Visiting Professor of Finance at Tilburg University – Netherlands. He is author of the just published book “What Investors Really Want” and writes at his blog What Investors Want. For further information see Vita.
We might describe ourselves as ambitious and other people as greedy, but ambition and greed are more similar than different. Ambitious people and greedy ones might be rich in money relative to the average American, Canadian, or South African, but they are poor in ego. Ambitious people and greedy ones feel like losers, way below their aspirations for money, status, esteem, or respect. Feeling like a loser is as psychologically painful as that physical pain in the chest, but both kinds of pain are useful, prodding us into action. The action we take can be smart, whether looking for a better job or calling an ambulance, or it can be stupid. And some actions which are stupid when done in excess, such as buying lottery tickets, can be reasonable, even smart, when done in moderation, such as buying a one-dollar lottery ticket every week.
Lottery authorities advertise them as entertainment. “The lottery is fun. Entertaining. Exciting.” But we do not buy lottery tickets because we want to be entertained, we buy them because we want to reach our aspirations. We are driven to gamble, whether through lottery tickets or stocks, when we feel poor. And we are driven to gamble when we are reminded that we are poor. Experimenters paid people waiting at a bus station $5 in single dollar bills to complete a questionnaire. One version of the questionnaire, given to half the people, was designed to make them feel adequate, with incomes in the middle of the income range. It asked whether their annual incomes were less than $10,000, between $10,000 and $20,000, and then, in increments, to the top category of more than $60,000. The other version of the questionnaire, given to the other half, was designed to make them feel poor. It asked whether their annual incomes were less than $100,000, between $100,000 and $250,000, and then in increments to the top category of more than $1 million. Next, the experimenters showed each person five $1 lottery tickets and asked how many they wished to buy. People who were made to feel poor bought more lottery tickets than people who were made to feel that their incomes were adequate.
We are driven to dream of power when we feel powerless. Sharon and Russ Gornie, a young couple who own a carpet store, felt powerless. “We are trying to make some aggressive money very quickly,” said Sharon. The couple lives in a modest house, far below their aspirations. “This is our dream house,” said Sharon, pointing to blueprints of a fancy house. “We look at it when we are off to work in the morning and when we come home tired. . . . Isn’t it beautiful?”
Experimenters asked one group of people to reflect on situations in which they felt powerless and asked another group to reflect on situations in which they felt powerful. They found that people who were made to feel powerless were more eager to buy high-status items such as silk ties than people who were made to feel powerful.
Aspirations for a home of our own drive us even if we should be guided by utilitarian benefits to rent rather than own. Many are seduced by the expressive and emotional benefits of a beautiful dream house. We take pride in home ownership and feel powerful, knowing that no landlord can kick us out. We take pleasure in our freedom to drill holes in walls for hooks to hold our favorite paintings. We take comfort in our freedom to knock down walls if we wish.
We might think of American subprime borrowers as greedy gamblers, lured into fancier houses than they could afford and larger mortgages. But hope and aspirations animated homebuyers more than greed. Steve Sanders, a mortgage banker, wrote that home buyers rushing to fulfill their dreams were willing to sign anything placed in front of them. “After witnessing literally thousands of signings,” he wrote, “I will tell you that most people are so focused on getting into their new home that they have no idea what it was they just signed.”
Pain in the chest does us good when it prods us to call an ambulance, but it does us no good when surgeons open our chest. Anesthetics do us good when they take away pain during surgery. Similarly, ambition does us good when it prods us to reach our aspirations by seeking a good job or starting a good business. But ambition does us no good when it drives us into what we cannot reach. The fox in the fable knows the anesthetic for excess ambition; sometimes it is smart to conclude that the grapes you cannot reach are sour anyway, and move on.
Emotions, like cognitive errors, can mislead us into costly beat-the-market games. Perhaps we would stop playing these games after we are educated. Then we would avoid the pitfalls of cognitive errors and emotions and focus on the utilitarian benefits of investments. Yet most investors continue to play beat-the-market games despite much education. Even financially literate investors prefer beat-the-market funds over index funds. It is time to accept the fact that we engage in beat-the-market games not only because we are financially illiterate but also because we are willing to sacrifice some of the utilitarian benefits of our investments for expressive and emotional ones. We want the fun of playing beat-the-market games and the pride of winning them.
Sometimes ego can come between the investor and riches.
Book Review: ‘What Investors Really Want’ by Meir Statman by John Lounsbury