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What Investors Really Want

August 6, 2010

We want more from our investments than a reasonable balance between risk and return. We want to nurture hope for riches and banish fear of poverty. We want to win, be number one, and beat the market. We want to feel pride when our investments bring gains and avoid regret when they inflict losses. We want the status conveyed by hedge funds, the virtue conveyed by socially responsible funds, the patriotism conveyed by investing in our own country, and the loyalty conveyed by investing in the companies that employ us. We want financial markets to be fair, but we search for an edge that would let us win. We want to leave a legacy for our children when we are gone. And we want to leave nothing for the tax man.

Standard finance proclaims that investors are rational, free of cognitive errors. Much of behavioral finance says that investors are irrational, beset by a host of cognitive errors. Lost in the middle are normal investors like you and me. We are intelligent people, neither rational nor insane. We are “normal smart” at some times and “normal stupid” at others. But we must distinguish investment wants from cognitive errors and empathize with fellow investors who do not share our wants.

Some of us are willing to pay money for the game of golf, including the cost of clubs, balls, and fees. Golf seems useless to me—a cognitive error that misleads avid players into spoiling a good walk. But I empathize with golf’s passionate players even if I don’t share their passion. Some of us are passionate players of the investment game, willing to pay commissions for trades, subscriptions for newsletters that promise to foresee the market, and fees for mutual funds that promise to beat it. I empathize with their passion as well, even if I don’t share it.

Investments offer three kinds of benefits: utilitarian, expressive, and emotional. Utilitarian benefits are the answer to the question, What does it do for me and my pocketbook? The utilitarian benefits of watches include time telling, the utilitarian benefits of restaurants include nutritious calories, and the utilitarian benefits of investments are mostly high returns with commensurate risk. Expressive benefits convey to us and to others our values, tastes, and status. They are the answer to the question, What does it say about me to others and to me? A stock picker says, “I am a winner, able to pick winning stocks.” Emotional benefits are the answer to the question, How does it make me feel? The best tables at prestigious restaurants make us feel proud, private equity makes us feel important, lottery tickets and speculative stocks give us hope, and stock trading is exciting.

We are not embarrassed to admit that we want our investments to support us during our retirement years. Nor are we embarrassed to admit that we want our investments to support our children or favorite charities. But some of what we want from our investments is embarrassing. We might want to mention our investments in hedge funds, knowing that hedge funds signal high status because they are available only to the rich. But a loud expression of status, like a display of an oversized logo on a Gucci bag, can bring embarrassment rather than an acknowledgment of status. Wants are also difficult to acknowledge because they often conflict with “shoulds.” The voice of wants says, “I want this new, red sports car,” but the voice of shoulds says, “You should buy a used sedan and add the difference in price to your retirement account.” Investment advice is full of shoulds—save more, spend less, diversify, buy and hold. Wants are visceral, whereas should are reasoned. Wants emphasize the expressive and emotional benefits of investments, whereas shoulds emphasize the utilitarian benefits.

Marketing professionals are not puzzled by the commingling of utilitarian, expressive, and emotional benefits. Indeed, such commingling is at the center of their work. Marketing professionals know that watchmakers can sell $10 watches for $10,000 by commingling the watches’ time-telling utilitarian benefits with the expressive and emotional benefits of status. But investment professionals and professors of finance prefer to keep their distance from marketing, in words if not in actions. They are often perplexed by the commingling and are uncomfortable with it. Yet investment professionals and professors of finance cannot hope to understand the world of investments without understanding this commingling, and investment professionals cannot serve their clients well without that understanding.

Financial advisers are often puzzled by the desire of some investors to exclude the stocks of tobacco companies from their portfolios. Why not invest in tobacco stocks if they produce the highest returns and then use those returns for antismoking campaigns? This suggestion makes as much sense to socially responsible investors as a suggestion to Orthodox Jews that they forgo kosher beef for cheaper and perhaps tastier pork and donate the savings to their synagogues.

Money managers often assert that they compete with other money managers by generating the highest alphas and denigrate the role of marketing in the competition. Yet every money manager has stories about other money managers with low alphas who snatched clients through clever marketing.

Money managers, financial advisers, security designers, and all other investment professionals practice marketing when they seek to understand investor needs—utilitarian, expressive, and emotional—and satisfy them. Yet investment professionals are reluctant to discuss marketing, and few articles link marketing to the investment profession. The time has come to make the link between investment and marketing stronger and more explicit.

Although researchers are still looking for models of expected returns that recognize the role of utilitarian risk, they seem uninterested in finding models that recognize the roles of expressive and emotional characteristics. We have moved from the capital asset pricing model, in which beta measures risk, to the three-factor model, in which size and book to market measure risk. But size and book to market probably measure affect, an expressive and emotional characteristic, more than they measure risk. The stocks of Google, Apple, and other growth companies have positive affect, which attracts investors, whereas the stocks of Citigroup, Bank of America, and other value companies have negative affect, which repels investors. We need to include in models of expected returns such expressive and emotional characteristics as affect, social responsibility, status, and patriotism.

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