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Self-awareness is power-Business Times

October 26, 2010 Comments off

I was recently interviewed by Singapore based Business Times. They were kind enough to let me post the article on this blog.

Business Times – 02 Oct 2010

Self-awareness is power
Knowing yourself, your goals, and errors is the first lesson in behavioural finance. By Genevieve Cua

BUY-AND-HOLD investing came in for a hammering with the crisis of 2008, as did diversification. Thanks to deep losses in the recent downturn, more advisers have begun to trade client portfolios more actively at the margins, an exercise called ‘tactical’ asset allocation – or, to put it more plainly, market timing. But this practice came in for a beating at a talk earlier this week at the Private Wealth Management Conference organised by the CFA Institute.

In a talk laced with humour, Meir Statman     , Glenn Klimek professor of Finance at Santa Clara University, had a very clear message for investors and advisers. Prof Statman’s research focuses on behavioural finance. The first lesson, he says, is to know yourself, your goals, and errors. The second is to assure yourself by knowing not just the science of financial markets and instruments, but also the science of human behaviour. He likens financial advisers to financial physicians. ‘Physicians take care of your health, and financial advisers your wealth and well being . . . Good financial advisers have to listen, empathise, educate. That’s a big job. ‘In standard finance, investors are rational. In behavioural finance, they are normal. People are not rational, they are normal. Sometimes we are normal smart, sometimes normal stupid. It would be nice if we could increase the ratio of smart to stupid, but we’re always people.’ People, he says, have been disappointed by diversification, which failed to provide any cushion from loss at the worst of the crisis. Assets in a portfolio are picked for their low correlations with each other, so that they should not rise or fall in tandem. But in a crisis, correlations among most assets spike.

‘Diversification assures you that you won’t have all your eggs in the crummiest asset. But it also means you won’t have your entire portfolio in the best. But you’d be in between. ‘People say I’m disappointed. There must be something better – market timing, tactical asset allocation. It’s tempting, but it’s the equivalent of jumping from the frying pan into the fire.’  He cites a joint study with Kenneth Fisher, to ascertain if the implementation of PE trading rules work. Between 1871 and 2002, US$1 invested in the stock market grew to about US$67,000 using a buy-and-hold mode. In contrast, a trading rule of investing whenever PEs dropped below 26 times would have netted roughly US$60,000. If market timing isn’t a panacea, why do many people – finance professionals included – believe that it is? A number of human traits can explain this: Overconfidence; ‘representative’ error which is the human tendency to find patterns where they may not exist. The latter error blurs the line between hindsight and foresight.

Trading, in any case, is a zero sum game, he says. ‘If I think the market is too high and I sell, someone else is buying it. There is an idiot in every trade and if you don’t know who it is, you’re in trouble . . .’You have to ask yourself: . . . What’s my information advantage to give me an edge? In all likelihood it’s nothing, you’re deluding yourself.’ Investors, he says, can protect themselves by making advisers their allies. ‘To advisers, I say make yourself worthy of the designation. ‘Knowing that you commit cognitive errors is the first step. The second is to remind yourself. Like me, you probably have problems creating defences.’  Advisers, he says, ‘have to continuously be teachers of our clients’. ‘You can’t say I told you that, that you know fear will cause you to be risk averse. You have to teach them again and again.’

While modern portfolio theory (MPT) is routinely taught in finance schools, it is impractical in practice. MPT has a number of key assumptions – that investors are rational and risk averse; that there are no trading costs, for instance. It points investors to ‘optimal’ portfolios which represent a combination of assets that give the maximum return for a given level of risk. The theory implies just one level of risk tolerance, says Prof Statman. ‘But we build portfolios not as a whole, as prescribed by (Harry) Markowitz, but in a pyramid. We buy money market funds for downside protection and stocks and lottery for the upside.’

Together with Hersh Shefrin, Prof Statman published a paper in 2000 on ‘behavioural portfolio theory’. It posits that investors have multiple mental accounts, and the resulting portfolio does not coincide with a traditional portfolio based on MPT and an efficient frontier.  The behavioural portfolio basically is a two-level pyramid where the lower layer is designed to avoid poverty, and the higher layer is designed ‘for a shot at riches’. Risk tolerance itself may be linked to culture. Prof Statman has written a paper on this – The Cultures of Risk Tolerance. He finds that people who are more trusting, for instance, are more willing to take risk. Those from countries where incomes are relatively low are more willing to take risk. In ‘collectivistic’ societies, where there is a family network and cohesive ties, risk tolerance is also higher. This could be because an extended family provides a downside cushion.

At the other end of the spectrum is the ‘individualistic’ society where individuals are expected to look after themselves. Singapore and China rank fairly low on the individualistic scale, and the highest ranked are the US and UK. Prof Statman himself keeps his investments ‘very, very simple’. ‘What do I do in a crazy market? I invest and close my eyes rather than try to pick out where the mania will go; it’s self-defeating.  ‘It’s very hard to explain to clients, but I think the way to do it is to say – here is what we know from science. Here are some studies I can show you about how people try to take advantage of cycles and fail.’ Once you’ve made the plunge to invest, switch off the noise from news commentators, he says. ‘I keep my investments very, very simple, and I think I’ve done very well. I invest exclusively in index funds and let stuff take its course. I have enough money in my downside protection account to make sure I’m not going to be poor. ‘The money in my upside account, I don’t do options. The stuff I have in equities, sometimes it goes up and it goes down. I shrug, what can I do? ‘If you train yourself to be like that, you will do yourself a great favour. It’s hard, (an adviser’s) business is transaction oriented, because I’m not going to give you much business. I don’t trade. I think (that’s) smart behaviour.’
Copyright © 2010 Singapore Press Holdings Ltd. All rights reserved.

Categories: Press

What investors really want: Searching for beat-the-market money managers

September 24, 2010 Leave a comment

Think of investments as ingredients of a stew, some with fat returns and some with lean. Now think of the investment market as a giant well-mixed vat of stew that contains all investments. Some investors dip their ladles into the stew and fill them with fat and lean in proportions equal to the proportions in the market vat. These are index investors who buy index funds that contain all investments. Index investors pay the expenses of their funds, but they can easily find index funds whose expenses are very low, equivalent to a few teaspoons of stew taken out of their ladles. Index investors tend to be buy-and-hold investors who trade only infrequently, as when they invest savings from their paychecks into index funds during their working years and withdraw them in retirement.

While index investors are satisfied with returns equal to risks, beat-the-market investors search for returns higher than risks. Some beat-the-market investors choose handfuls of investments and trade them frequently, hoping to fill their ladles with more fat returns than in the ladles of index investors. Others buy beat-the-market mutual funds, exchange traded funds, or hedge funds, hoping that their managers would find stocks with fat returns. But not all beat-the-market investors can be above average. The ladles of index investors are filled with average amounts of fat returns. If some beat-the-market investors fill their ladles with above-average fat returns, other beat-the-market investors are left with below-average fat returns in their ladles. Moreover, the expenses of beat-the-market investors are higher than those of index investors because beat-the-market investors pay higher costs of trading and the higher costs of beat-the-market managers. Beat-the-market costs are substantial. By one estimate, investors would have saved more than $100 billion each year by investing in low-cost index funds and foregoing attempts to beat-the-market by on their own or by paying money managers to do it for them.

The beat-the-market puzzle

Why don’t beat-the-market investors abandon their game and join index investors? One part of the answer is easy. While average beat-the-market investors cannot beat the market, some beat-the-market investors are above average. Professional investors, such as mutual fund and hedge fund managers, regularly beat the market. Stocks bought by beat-the-market mutual fund managers had higher returns than stocks sold by them. And hedge fund managers are famous for the billion-dollar paychecks they earn by beating the market. But investors in beat-the-market mutual funds trail investors in index funds because the costs of beat-the-market mutual funds detract from the returns passed on to investors more than managers add to them. Hedge funds are riskier than investors believe and the returns they pass on to investors are lower than investors believe.

Highly intelligent investors might be able to beat the market, but their success is far from assured because intelligent investors are not always wise. Harvard staff members are intelligent and so are Harvard undergraduate students with SAT scores in the 99th percentile as are Wharton MBA students with SAT scores at the 98th percentile. Staff and students received information about past performance and fees of index funds that track the S&P 500 Index. But the information about the funds varied by the dates when the funds were established and the dates when the funds’ prospectuses were published.

Wise investors faced with a choice among index funds following the S&P 500 Index choose the index fund with the lowest fees since these index funds are otherwise as identical as identical cereal boxes. But nine out of ten staff and college students chose index funds with higher fees and so did eight out of ten MBA students. Staff and students chased returns instead, choosing funds with the highest historical returns, apparently assuming that these offer returns higher than risks.

Insiders Deepen the Beat-the-Market Puzzle

Some investors have access to inside information, such as information about mergers being negotiated or disappointing earnings about to be revealed. Investors with inside information include corporate executives and investors with links to executives, including investment bankers and hedge fund managers. Members of Congress have inside information as well. Only one-third of American senators bought or sold stocks in any one year during the boom years of the 1990s but trading senators did very well. While corporate insiders beat the market by six percentage points each year on average, trading senators beat it by 12 percentage points. “I don’t think you need much of an imagination to realize that they’re in the know,” said Alan Ziobrowski, one of the authors of the study.

The success of insiders in the beat-the-market game only deepens its puzzle. Insiders fill their investment market ladles with above-average proportions of fat returns, while index investors fill their ladles with average proportions of fat returns. This leaves below-average proportions of fat returns in the ladles of outsiders in the beat-the-market game, even if we set aside the cost of playing the game.

A two-part solution to the beat-the-market puzzle

Why don’t outside investors quit the beat-the-market game? Why do investors search for money managers who would bring them ladles of beat-the-market returns even after managers have scooped expenses and compensation from the ladles? One part of the answer is in cognitive errors and emotions which mislead us into thinking and feeling that we or our managers can easily beat the market. The other part is in what we really want from our investments, including our desire to play the investment game and win.

Framing errors are some of the cognitive errors which mislead us into thinking that beating the market is easy. In particular, we fail to frame the investment market as a vat of investment stew where relatively high returns for one investor imply relatively low returns for another. You might object, noting that there are many investment vats rather than one. Some investment vats, such as the private equities vat, might have more fat returns in them than the vat of public equities. Private equity vats, unlike public equities vats, can be consumed only by large investors, undisturbed by hordes of small investors. Yet investors in private equities are far from assured that their managers would share the fat. Tom Perkins, a wealthy manager of a venture capital, tells about Harry, one of his investors, who asked him how he can live with the risk of his investments. “Well, Harry,” laughed Perkins, “it’s your money!”

Emotions join cognitive errors in persuading investors that beating the market is easy. Individual investors are often unrealistically optimistic, but they are regularly joined by professional investors who are flattered as sophisticated players just before they are fleeced. Lloyd Blankfein, the chief of Goldman Sachs, described investors who lost to Goldman at the mortgage securities game as sophisticated investors. But Phil Angelides, who questioned Blankfein at the Financial Crisis Inquiry Commission, said: “Well, I’m just going to be blunt with you. It sounds to me a little bit like selling a car with faulty brakes, and then buying an insurance policy on the buyer of those cars, the pension funds who have the life savings of police officers, teachers.” Jeff Macke, an investment advisor, elaborated: “Of course [Goldman Sachs traders] know more than the other guys,” he said to Paul Solman of PBS’ Newshour. And, if they’re selling it, well, you probably don’t want to be a buyer.” Macke failed to persuade Solman. “But pension funds don’t bring in the math whizzes, the quants, the people that Goldman Sachs has,” said Solman, “They’re no match for Goldman Sachs’ salespeople or traders.” Macke was ready when Solman was done. “Generally speaking, they aren’t,” said Macke. “So, what is a pension fund doing involved in these securities?” Unrealistic optimism is a likely answer. Pension fund managers believed that they had a realistic chance to win their game when, in truth, they were unrealistically optimistic.

What investors really want

J.H.B., the anonymous author of a 1930 book, Watch Your Margin: An Insider Looks at Wall Street, is speaking with W. E. Woodward, his friend:

“Do you know why people go into stock speculation?” asked J.H.B.

“To make money,” answered Woodward.

“Not at all,” said J.H.B., “They go in for the pleasure of getting something for nothing….What they want is a thrill. That is why we…drink bootleg whisky, and kiss the girls, and take new jobs. We want thrills. It’s perfectly human, but Wall Street is a poor place to look for thrills, for the simple reason that thrills in Wall Street are very expensive.”

J.H.B. was speaking in 1930, when Prohibition was the law, and whisky was bootlegged. The world has changed greatly since then, but our wants remain the same. Woodward is not entirely wrong. We do want to make money from investing and speculating. But J.H.B. is surely right. We want pleasure from investing and speculating, and we want thrills from playing the beat-the-market game and winning it. Wall Street is still a poor place to look for thrills and Wall Street thrills remain expensive, but we are willing to pay the price.

Investments offer three kinds of benefits: utilitarian, expressive, and emotional, and we face tradeoffs as we choose among them. The utilitarian benefits of investments are in what they do for our pocketbooks. The expressive benefits of investments are in what they convey to us and to others about our values, tastes, and status. Some express their values by investing in companies that treat their employees well. Others express their status by investing in hedge funds. And the emotional benefits of investments are in how they make us feel. Bonds make us feel secure and stocks give us hope.

Profits are the utilitarian benefits of winning the beat-the-market game, and cognitive errors and emotions mislead us into thinking that winning is easy. But we are also drawn into the game by the promise of expressive and emotional benefits. Indeed, we are willing to forego the utilitarian benefits of profits for the expressive and emotional benefits of playing the beat-the-market game and hoping to win that game.

Dutch investors care about the expressive and emotional benefits of investing more than they care about its utilitarian benefits. They tend to agree with the statement “I invest because I like to analyze problems, look for new constructions, and learn” and the statement “I invest because it is a nice free-time activity” more than they agreed with the statement “I invest because I want to safeguard my retirement.” German investors who find investing enjoyable trade twice as much as other investors. And a quarter of American investors buy stocks as a hobby or because it is something they enjoy.

Mutual Funds magazine interviewed Charles Schwab, the founder of the investment company bearing his name. Schwab said: “If you get… an S&P Index return, 11% or 12% probably compounded for 10, 15, 20 years, you’ll be in the 85th percentile of performance. Why would you screw it up?”

The interviewer went on to ask Schwab why he thought people invested in actively managed funds at all. “It’s fun to play around,” answered Schwab. “People love doing that, they love to find winners… it’s human nature to try to select the right horse. It’s fun. There’s much more sport to it than just buying an index fund.”

It is often hard to distinguish facts from cognitive errors and even harder to distinguish cognitive errors from wants of expressive and emotional benefits. We should empathize with fellow investors who do not share our wants. 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 money managers that promise to beat it. I empathize with their passions even if I don’t share them. Yet I see no benefit in cognitive errors and emotions that mislead us into sacrificing utilitarian benefits for no benefits at all. No benefit comes from playing the beat-the-market game because we fail to understand that it is difficult to win. And no benefit comes from failing to make wise choices among utilitarian, expressive, and emotional benefits. We can increase the sum of our benefits if we understand our investment wants, overcome our cognitive errors and misleading emotions, weigh the tradeoffs between benefits, and choose wisely.

Table of Contents

August 11, 2010 Leave a comment

This book will be published by McGraw-Hill in November 2010. It is available by advance orders at Amazon, Barnes and Nobles, and Borders.

What Investors Really Want is about what we want from our investments. It is about how we think about our investments, how we feel about them, and how investments drive us crazy as we try to cajole them into giving us what we want. This book is about normal investors like you and me. We are intelligent people, neither irrational nor insane. We are normal-smart at times and normal-stupid at other times. We should increase the ratio of smart behavior to stupid behavior, but we do not have computers for brains and we want benefits computers cannot comprehend.

As you read this book, you will recognize the cognitive errors and emotions that stand in your way to smart financial decisions. And you will learn to overcome them. You will also reflect on what you want from your investments, beyond money. We care about how we make our money. Socially responsible investors avoid tobacco stocks even if they offer high returns. Hedge fund investors get a dose of status in addition to money. Stock pickers seek the challenge of stock puzzles just as their spouses seek the challenge of crossword puzzles. We also care about what we do with our money. We invest in our children our love, energy, and hopes (and our money).

What Investors Really Want combines knowledge from rigorous academic studies with anecdotes illustrating that knowledge. It is written in plain language, full of fun and free of jargon. Studies and anecdotes in the book extend much beyond finance, yet they serve to highlight what we must know about finance. Studies and anecdotes also extend much beyond the United States to Australia, China, Japan, Mexico, Italy, Germany, Argentina, and elsewhere.

Table of Contents

Introduction: What we want

We want high returns from our investments, but we want much more. We want to nurture hope for riches and banish fear of poverty. We want to be number one and beat the market. We want to feel pride when our investments bring gains and avoid regret when they bring losses. We want the sophistication of hedge funds and the virtue of socially responsible funds. We want to leave a legacy for our children when we are gone. And we want to leave nothing for the tax collector.

We want three kinds of benefits from our investments: 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 investments are mostly wealth, enhanced by high investment returns. Expressive benefits convey to us and to others our values, tastes, and status. They answer the question, “What does it say about me to others and to me?” Hedge funds express status, and socially responsible funds express virtue. A stock picker says, “I am smart; I am able to pick winning stocks” Emotional benefits are the answer to the question, “How does it make me feel?” Insurance policies make us feel safe, lottery tickets and speculative stocks give us hope, and stock trading is exciting.

Chapter 1: We want profits higher than risks

Investments with returns equal to their risk are as easy to find as good lunches at fair prices. But we want free lunches, not fair ones, and we are always searching for investments with returns higher than risks. “Why should I invest money at four and a half percent when I can get six percent . . . ?” asked an investor a century ago. Because the six percent bond is likely to be riskier than the four and a half percent bond, answered a wise advisor. Yet old lessons need to be taught again because we fail to learn.

Chapter 2: We have thoughts, some erroneous

Cognitive errors mislead us into thinking that investments with profits higher than risk are easy to find. Availability errors are one example. Investment companies increase the availability of winning investments in our minds by highlighting them in their advertisements while obscuring losing investments. This leaves us with the impression that winning is easy. Other cognitive errors include hindsight errors, which mislead us into thinking that we have seen winners and losers in foresight when, in truth, we have seen them only in hindsight, and framing errors, which mislead us into believing that all traders can be winners.

Chapter 3: We have emotions, some misleading

Emotions draw us into a search for investments with returns higher than risk and give us false confidence in our ability to find them. Emotions include sentiment, which misleads us into believing that some investments combine high returns with low risk; exuberance, which highlights returns and obscures risk; fear, which highlights risks and obscures returns; and unrealistic optimism, which leads us to exaggerate our skills and chances of finding investment with returns higher than risks.

Chapter 4: We want to play and win

The game of finding investments with returns higher than risks is tempting, even when we know that it is difficult to win. Playing the game makes us feel alive, in the groove, in control, and in the flow. This is the experience of athletes in the zone, car drivers going fast and changing lanes decisively, or day-traders enthralled by the flickering colors of their monitors. The challenge of a difficult game only enhances the joy of winning it. We like to play the game alone and we like to play it in communities, such as in investment clubs, where the benefits of playing the game extended to friendship and camaraderie.

Chapter 5: We stampede in herds and inflate bubbles

Herds of bullish investors stampede into investments and herds of bearish investors stampede out. We join herds because we think that bulls or bears in the herds know where they are charging. And we dread being left behind. Investors rush into stocks fearing that they would be left behind their friends and neighbors. Executives of hot companies rush to issue stocks to eager investors and entice them with wildly optimistic forecasts. In time, investors see the truth, and stock prices plunge as investors stampede out. Our herding instinct also opens the door to frauds, where fooled members pull in other members and all turn into losers.

Chapter 6: We want strong self-control and clear mental accounts

We care whether our aunt labeled money she left to us as “inheritance” or “legacy.” We do not spend “hard-earned” dollars as easily as we spend dollars we won in a lottery. We often place monies in distinctly labeled mental accounts and treat them accordingly. We spend inheritance money but we are likely to keep legacy money for our children and grandchildren. Simplified accounting is one benefit of mental accounting. But the benefits of mental accounting as a tool of self-control are even greater. Self-control stops us from buying a shiny new car today when we need the money for tomorrow’s rent. And self-control stops us from going on a vacation today so we might enter a nursing home in old age.

Chapter 7: We want to save for tomorrow and spend it today

How much money should we save for a comfortable retirement and how much can we spend today? Some are calculating how much to save today. Others are calculating how much to spend each month in retirement. But most of us just muddle our way through the years in an uncertain world, trying to strike a balance between saving too little and saving too much. Our capacities for mental accounting and self-control help us sometimes and stand in our way at other times. Mental accounting helps us distinguish what we are permitted to spend from what we must save. Self-control helps us manage our conflicting desires to save and spend.

Chapter 8: We want hope for riches and freedom from the fear of poverty

People who hate risk buy insurance policies, while people who love risk buy lottery tickets. Yet most of us buy both, just as most of us buy both safe bonds and risky stocks. We are motivated by our twin desires of hope for riches and freedom from the fear of poverty. We build our investment portfolios as layered pyramids of mental accounts. We place bonds in a mental accounting layer at the bottom of the pyramid, designed to free us from the fear of poverty, while we place stocks in a mental accounting layer closer to the top of the pyramid, intended to give us hope of riches. In practice, pyramid portfolios include many layers, each associated with a goal: retirement income at the bottom of the pyramid, college education in the middle, and at the top perhaps being rich enough to tell our boss we’re quitting our jobs to spend our lives on cruise ships.

Chapter 9: We have similar wants and different ones

We all hope for riches and freedom from the fear of poverty, but some of us are more passionate about hope, while others care more about freedom from fear. The balance each of us strikes between hope and freedom from fear is shaped by our personalities, circumstances, life experiences, and cultures. Personality matters. Extroverts care about hope for riches more than introverts. Culture matters. People crave freedom from fear in countries where uncertainty avoidance is high. People crave it less in countries where uncertainty avoidance is low.

Chapter 10: We want to face no losses

Profits bring pride as well as money, while losses inflict regret. We check our investment accounts often when we know that they would show gains but we leave envelopes unopened when we know that statements would show losses. Realizing gains by selling investments at a profit intensifies pride because it brings profits into our hands. Realizing losses is especially painful because we give up hope of recouping our losses. This is why we tend to realize gains in haste and procrastinate in the realization of losses. Investors who do not make peace with their losses often dig themselves into deeper losses and throw good money after bad.

Chapter 11: We want to pay no taxes

High returns are the utilitarian benefits of tax-free funds; investors who send less to the IRS keep more for themselves. But tax-free funds and other tax-saving investments have expressive and emotional benefits as well. We express ourselves as high-income investors, with status as high as our tax brackets. We express ourselves as smart, savvy, wily, and crafty, which is what it takes to avoid taxes. Pride at avoiding taxes is emotionally satisfying, but the emotions accompanying taxes extend to anger and hatred. We are angry when taxes rob us of personal freedom or when they are wasted by politicians and bureaucrats. Indeed, we are often willing to spend an extra $5,000 to save $4,000 in taxes.

Chapter 12: We want high status and proper respect

While wealth is absolute, status is relative. The rich accumulate more wealth than they or their heirs can reasonably consume, in part because accumulated wealth brings status. Hedge funds open their doors only to the rich, making it easy for investors to brag about their riches without appearing to brag. Hedge funds are a status investment, and so are investments in art, wine, and movies. Wealth boosts self-confidence and applies balm when slighted by others, but even wealth does not always bring respect. Women investors resented disrespect a century ago ,and they resent condescending attitudes today.

Chapter 13: We want to keep true to our values

Socially responsible investors are prominent among those willing to sacrifice money for values. Some social responsibility communities express a single value, such as protection of the environment, while others express several values, such as avoidance of tobacco, alcohol, and gambling. The Ave Maria Catholic Values fund eliminates from its portfolio stocks of companies associated with contraceptives and abortions. The Amana funds avoid bonds and other interest-paying investments because they violate the Islamic prohibition on interest payments or receipts. Values extend beyond social responsibility to patriotism, ideology, and philanthropy.

Chapter 14: We want fairness

We want to play on level playing fields in sports, investments, and every other field. We want fair stock markets where our chances at winning depend on our skills, savvy, or even luck, not ones where our chances are diminished by those who have fast computers or inside information. We want to be treated fairly by financial advisors and money managers. And we are willing to sacrifice money for the expressive and emotional benefits of fairness. We boycott stores that treat their employees unfairly even when we pay higher prices at other stores, and we forego profits to avoid financial advisors whose fairness we suspect.

Chapter 15: We want to invest in our children and families

Parents have always invested in their children. A 1929 advertisement by a bank says: “Invest today for their tomorrow.” Education tops the list of concerns of many parents, expressed in prodding children to do well in school and in savings accounts for college expenses. And while middle-class parents worry that they might not have enough for their children’s college education, rich parents worry that their children would feel entitled to spend what they do not earn. ‘‘Leaving children wealth is like leaving them a case of psychological cancer,’’ said one rich father. Sometimes we as children help our parents, as when we care for them in old age, and sometimes we help poorer members of our families, as when we send money we earn in developed countries to our families in developing countries.

Chapter 16: We want education, advice, and protection

We are increasingly responsible for our financial futures as company pensions disappear. Yet many old investors lack financial literacy, failing to understand even the basics of stocks and bonds and the importance of investment fees. Financial literacy among the young is no better. Less than one-third of young adults possess basic knowledge of interest rates, inflation, and the risk-reduction benefits of diversification. We seek information, protection, and advice from financial advisors, governments, television, the Internet, and other investors. Some of the advice we receive is good and some is bad. Some delivers what we want and some does not. Some sticks with us and some washes away. We want protection from others who might urge us into poor investments or defraud us, and we want protection from ourselves when greed and gullibility urge us into poor or fraudulent investments.

Conclusion: What we have

One of the many challenges facing us is the challenge of distinguishing truth from wants and from the cognitive errors we commit as we try to reach our wants. We might choose to trade stocks because we have a true advantage over other traders or because cognitive errors mislead us into thinking that we have an advantage. Moreover, we might choose to trade even when we know that other traders have an advantage simply because we want to enjoy the thrill of trading. Yet it is important that we distinguish truth from wants and from cognitive errors.

It is even more important to remember that investments are about life beyond money. We can enjoy the benefits of investments ourselves, indulging in a few luxuries, or we might enjoy them with family, friends, and people in our neighborhoods and faraway continents. But, in the end, we cannot take our investments with us.