Last Updated Jul 21, 2011 2:08 PM EDT
Most investors are eager to learn how they can make smarter financial decisions for higher investment returns. In his latest book What Investors Really Want, behavioral finance expert Meir Statman explains what's preventing most investors from making more money and why people invest their money how they do.
In my recent hour-long interview, Meir takes a realistic view of finance and looks at what we want as investors, what we do, how we make financial decisions, and how we can make better financial decisions.
Here's an excerpt from our interview. Be sure to listen to the full Meir Statman Behavioral Finance interview on Richer Life Insights now!
Robert: You say that most investors don't make a lot of money. And so, that's what I hope we can change here today because I want the listeners to start making some smarter financial decisions, and I want them to make some money. What is preventing them from making the kinds of investment returns that they should be making?
Meir: Well, part of the answer is in the errors they're making and part is what it is that they truly want, and sometimes they are not aware of their tradeoffs. And so, think about it this way, if you want a good car at a good price buy a Honda Accord. If you want to have a good portfolio with a good return, construct the portfolio with low cost index funds. But, if you want some more status buy an Acura. And if you want more pizzazz buy a Honda sports car. And so, the same applies to investments. So, here's what I would say. If you really want to focus on returns, in all likelihood index funds are your way of doing that. If you think that by trying to beat the market you're going to get higher returns, I have news for you. You are not likely to do that. If you enjoy the game of beating the market, go ahead, but don't tell me that you are doing that to get higher returns.
Robert: I just want to make sure that I get what you're saying and that the listeners really understand what you're saying. If an investor wants the best possible return that they're realistically going to get, then they should invest in low cost index funds. Would that be accurate?
Meir: If they're only concern really is in getting a high return or rather a return that is consistent with the risk they're taking, in all likelihood the best portfolio is one of index funds, yes.
Robert: Okay. So, you know, they subscribed to Kiplinger's and Money Magazine and Smart Finance and watch CNBC and they do all of these things in order to try to get a little bit of a better return, but what you're saying is, you know what, at the end of the day maybe a month or a quarter, you might make a little bit more but when the dust settles you're probably better off with a low cost index fund.
Meir: That is right. And here is the thing, it is very hard for people to accept that and the reason for it is because they framed the problem wrong. And they think, for example about this: If I am a surgeon the more I practice, the more I work and the more I do surgery the better my skills are. So, why wouldn't it be so in investments? But investments are different from surgery because the human body does not resist the surgeon. But there's always a trader on the other side of you and one of you is an idiot. If you buy because the stock is sure to go up, who is the idiot on the other side? Maybe it is you. And so, what people have to understand is that with index funds you're going to get the average return. If there are going to be people who are going to get above average returns, there must be people who will get below average returns. Now, Goldman Sachs is going to get above average returns and it's like where are you in this pecking order. Most individual investors are in the losing end, are in the below average return. They are providing the extra profits for Goldman Sachs. And so, I get out of the way of Goldman Sachs and I don't trade. And I think that people who really want to focus on returns might follow what I'm doing.
Be sure to listen to the full Meir Statman Behavioral Finance interview on Richer Life Insights.
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