Managing the Mental Aspect of Investing
by Meir Statman
Meir Statman is the Glenn Klimek Professor of Finance at Santa Clara University, Santa Clara, California, and author of the recently published “What Investors Really Want” (McGraw-Hill, 2011). I spoke to him recently about mental hurdles investors face when making investing decisions.
Charles Rotblut, CFA
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Charles Rotblut (CR): In your book, you talk about how people commit cognitive errors such as confirmation errors and hindsight errors. Can you elaborate on the kinds of cognitive errors that people commit when they make financial decisions?
Meir Statman (MS): I begin with framing errors. We tend to frame trading stocks, mutual funds, and other investments as tennis played against a practice wall, where we see the ball hit the wall and place ourselves at the right spot to hit it back. But the correct frame of trading is real tennis against a player on the other side of the net. Would you play tennis when Roger Federer might be on the other side of the net if the loser pays $100,000 to the winner? So why are you trading when Goldman Sachs might be on the other side of the net? Remember, there is an idiot in every trade, and if you do not know who it is, it is likely you.
Some investors who frame the trading game correctly as tennis against a player on the other side of the net are often tripped by overconfidence. They know that the better tennis player would win, but surely they are the better player. They know that there is an idiot in every trade, but surely it is the other trader who is the idiot.
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Discussion
I thought this was a great article..now I need to find out what managed payout funds at Fid./Vang. are??
posted about 1 year ago by Donald from Michigan
Very thought provoking article with lots of
real life examples.
posted about 1 year ago by Charles from Illinois
Interesting article reflects many of my ideas of investing. Will also look up managed payout funds.
posted about 1 year ago by Cecile from California
I have the tendency to relish the gains and kick myself for the losses. This puts the psychology in perspective.
posted about 1 year ago by Walter from New Jersey
What if your losses are in a Roth account and not available to offset poential gains?
posted about 1 year ago by Bob from California
Perhaps the best interview I've had the pleasure of reading. Salute' Meir Statman.
We should realize the best total return lies in taxable accounts. 'Wish I had realized that years ago!
posted about 1 year ago by Dewey from Texas
I am picky about what I read...I read this one; very substantive.
posted about 1 year ago by Larry from Florida
Very little of this article applies to those of us managing a self-directed IRA. Surely, Mr. Statman does not recommend the almost universal "buy and hold" strategy that financial advisors lazily use to get their 2% commission. He almost admits that the layman has no chance against his ilk, the insiders, big brokerages and high frequency traders. Check out Buffets extremely advantages terms when he "loaned" BAC $5 billion as a example. Dilution of common stock, anyone? AAII would serve its members better by not publishing generic pablum that can't be contested. Doubt that? Pick one thing that irritates you and submit a complaint to the SEC, CME or CFTC. Then, do the same thing you do when you buy a stock that looks good. Hold your breath and hope.
posted about 1 year ago by Ed from Maryland
Yes, a trader is not the same as an investor. As an investor, be diversified (with cash as part of allocation) and wait til the herd is panic selling to purchase undervalued assets. Sell them a few years later when everyone is optimistic and enjoy the rewards.
posted about 1 year ago by Richard from Illinois
I think the article is very thought provoking and i will use his recommendation on not taking credit for gains and shrug my shoulders when I have losses rather than holding them until they return to profitability, which may never happen as we all know.
posted about 1 year ago by Marvin from Illinois
I read this article last year and enjoyed it.
I read it again a year later, this time I took notes! Great insights such as: So why are you trading when Goldman Sachs might be on the other side of the trade? Remember there is an idiot in every trade, and if you do not know who it is, it is likely you. A great article to revisit once a year!
posted 5 months ago by Steven Duncan from New York
