When it comes to investing, women are the fairer sex

(MoneyWatch) For centuries, women have been referred to as the fairer sex. I could not find a satisfying explanation of the origin, but it's a fair guess it was coined by a male, probably because he found women more attractive than men. One thing we do know is that when it comes to investing, and financial matters in general, women are definitely the fairer sex. Let's see why this is true.

The Spectrem Group conducted a survey to determine if the Mars/Venus divide extends to financial matters. The following is a summary of its findings:

  • Women were more inclined to worry about every aspect of financial matters and make more deliberate investment decisions.
  • Their generally more conservative approach made women more likely than men to use frugality as a wealth building strategy.
  • Women were more likely than men to cut spending and increase savings in response to economic concerns.
  • Men were more inclined to take on investment risk -- they were twice as likely to describe themselves as "most aggressive" and "aggressive" investors.
  • The willingness to take on investment risk goes hand-in-hand with investment confidence -- men were more than twice as likely to say they are "very knowledgeable" about financial products and investments, while women were more than twice as likely to say they're "not very knowledgeable."

The surveys raise some interesting questions:

  • Is the greater confidence of men in their investment knowledge justified? Does it result in superior performance?
  • Is the greater willingness of men to take more investment risk rewarded?
  • Is the greater frugality of women the right approach?

Fortunately, there are academic papers to help us answer these questions. Thanks to a series of studies, we know that the greater confidence of men in their financial skills, which probably contributes to their willingness to take on more risk, isn't justified -- women investors have achieved superior results. The following is a brief summary of that evidence.

The study "Boys Will Be Boys" examined the role that gender played in investment returns. The study covered the performance of 35,000 households at a large brokerage house from February 1991 to January 1997. The authors found that both women and men were lousy stock pickers -- both sexes produced returns below appropriate risk-adjusted benchmarks. On average, the stocks they bought went on to underperform, and the stocks they sold went on to outperform. Both sexes would have been better off if they simply held the portfolios they began the year with. However, because women traded less, incurring lower costs, they produced higher net returns, the only kind you get to spend.

Men traded 45 percent more than women. The costs of the higher turnover reduced the returns of men by 2.7 percentage points per year for men versus 1.7 percentage points per year for women. The difference in turnover rates for single men and women was even greater. The turnover of single men was 67 percent greater than that of single women (presumably because of the lack of influence from their more cautious spouses). Thanks to the increased turnover cost, single men underperformed single women by 1.4 percentage points per year. We could probably label this the "testosterone factor."

It seems likely that turnover rates are highly correlated with confidence levels. The most confident tend to trade the most. And men are more confident than women. For example, authors of the study "Patterns of Investor Strategy and Behavior Among Individual Investors" found that men believed that returns are more predictable than do women. Overconfidence is an all-too-human trait, and when it comes to investing, it is an expensive behavioral error because those who trade the most perform the worst. The authors of the paper "Do Investors Trade Too Much?" found that the average individual who traded the most underperformed a market index by more than 5 percent per year. On a risk-adjusted basis the underperformance increased to 10 percent per year.

Another explanation for the higher level of trading is that men may have a greater preference for gambling than women, accounting for their greater trading activity and lower net returns.

Setting women's superior results, the evidence demonstrates that both sexes would be better off giving up the hope of outperforming the market. They would both be better off joining the trend toward indexing and passive investing in general.

The research also shows that women's more conservative approach to finance in general is also the right strategy. For example, the paper "How Important is Asset Allocation to Financial Security in Retirement?" examined which metrics are the most important to achieving one's goals. The authors looked at how allocating assets, delaying retirement, tapping housing equity through a reverse mortgage and controlling spending impacted the ability to retire having achieved one's financial goal of a certain amount of spending. The following is a brief summary of the findings. As you review them, keep in mind that the findings are based on the average family, which typically has little in the way of financial assets. The greater one's financial assets, the greater the impact the asset allocation decision will have.

  • Starting to save at an early date has a large positive impact. Starting to save at age 25, rather than age 45, cuts the required saving rate by about two-thirds.
  • Delaying retirement has a large positive impact. Moving retirement from age 62 to age 70 reduces the required saving rate by about two-thirds.
  • The combination of saving early and retiring is so powerful that an individual who starts at 25 and retires at 70 needs to save only 7 percent of earnings to achieve an 80-percent replacement rate at retirement -- one-tenth of the rate required of an individual who starts at 45 and retires at 62 - an impossible 65 percent.

The analysis then looked at how important the asset allocation decision was relative to the impact from the other levers. While a higher expected return from a higher stock allocation does mean that smaller contribution rates are required, it's not a free lunch -- it comes with more risk. The authors found that even ignoring risk, the required saving differentials are less than those associated with ages for starting to save and the age of retirement. They found than an individual can offset the impact of a 2 percent return instead of a 6 percent return by retiring at 67 instead of 62. And the further along people are in their career, the more effective working a few years longer becomes.

The authors concluded that for the average individual starting early and working longer were far more effective levers for gaining a secure retirement than earning a higher return.

The bottom line is that when it comes to finance and investing, women are definitely the fairer sex. We can also conclude that when it comes to financial and investment matters, husbands should be paying a lot more attention to their wife's advice.

Image courtesy of Flickr user Midwest Family Life.