Men vs. Women: How to Be the Best Investor
The S&P 500 returned 8.21 percent in the 20 years ending in 2012. Naturally, you might expect the average investor’s return to be somewhere in that neighborhood. The reality is that the average investor has experienced significantly lower investment returns at 4.25 percent — almost a full 4 percent lower than those generated by the passive S&P 500 portfolio. Why can’t the intelligent human mind with its flexibility and arsenal of investing tools beat the unmanaged index? The reason is quite simple: we are irrational beings.
The Irrational Human: A Survey of Biases
We make decisions based on fear or greed rather than sound reason and logic. Psychologists and behavioral economists have catalogued the cognitive and emotional tendencies that inhibit our ability to make rational, unbiased decisions. Here is a summary of the most prominent biases:
- Availability bias: An investor makes decisions based upon the information that is readily available and his/her awareness of it.
- Representative bias: An investor makes decisions based upon history and stereotypes.
- Confirmation bias: An investor who has already decided upon a course of action will look for evidence to support his/her decision while ignoring anything to the contrary.
- Anchoring: After being presented with a reference point, an investor overweights that reference point relative to new information in making decisions.
- Overconfidence: An investor will believe his/her decision will always be a good one.
- House Money effect: An investor will treat money gained through investing profits as “free money” and tend to make riskier decisions with that money.
- Myopia: An investor will check results often and take action based on short term performance.
- Loss aversion: An investor’s pain of loss is greater than the joy from gain.
- Pride and regret: An investor has a need to feel proud of making a profitable investment and not experience the regret of having made a poor investment decision.
- Endowment effect: An investor places a higher value on what he or she owns over what the market does.
- Snake Bite Effect: An investor who has had a negative experience, when presented with a similar situation, will avoid that strategy whether or not it reflects his or her needs and goals.
All of these biases have been very well studied by several behavioral economists in relation to investing. The conclusion? These psychological barriers cost investors quite a bit of money. What is not as well studied, but perhaps even more interesting, is the question of gender differences when it comes to investing biases. To be precise:
- Do men and women both have the same biases?
- Are there behavioral differences between men and women when it comes to investing?
There is substantial literature for Question No. 2, which concludes that women are better investors than men. Question No. 1 is not as often directly studied (which prompted us to take our own look in the article, Real Data Suggest Gender Biases in Investing.) In this post, I seek to delve further into the behavioral patterns of men and women to see if they suggest different investing biases. To begin, let us start with analyzing the evidence supporting the claim that women are better investors than men. Is there any inherent advantage to being a woman in business?