New research suggests that neither faction has a monopoly on prejudices or rational thinking
The rise of fintech has allowed more individuals than ever to gain information on and invest directly in the stock markets. Still, some insist that there’s a gap between professional investors — the so-called “smart money” who know how to make investment decisions — and individuals, disparagingly called the “dumb money” because of their supposed naivete and proneness to bias.
But according to recent research, the distinction between the two groups isn’t so stark. In a recent piece, Wall Street Journal columnist Jason Zweig shared the findings of Finance professor James Choi of Yale University and law professor Adriana Robertson of the University of Toronto.
Through a sample of more than 1,000 people in the US, 59% of whom said they owned stocks, the two found that individual investors’ decisions were underpinned by principles cited in economic theory. For example, one third to one half of respondents said they considered how secure their employment is, the stability of their family’s health, and the likelihood of their homes retaining significant value when determining how much money to put in stocks.
The expected timing of retirement and major non-retirement expenses like tuition or a down payment on a home should also be factors, which they were for 36% to 48% of those polled. For another 46%, the prospect of an economic disaster was another major consideration in determining how much money they keep in stocks.
Still, the research found some myths persisting among small investors. Among those who invested in active mutual funds, 51% said the expectation of a higher return was very or extremely important to their decision. Another 46% thought that past outperformance is “strong evidence that its manager has good stock-picking skills,” and 27% were counting on the stock pickers to outperform in bad economic conditions.
“Over the long run, however, roughly 80% of mutual funds fail to beat their market benchmarks—whether they performed well in the past or not,” Zweig said, referring to data from past S&P Indices Versus Active (SPIVA) scorecards. “On average, they don’t perform better in down markets.”
That’s not to say that professional money managers don’t have their fair share of blind spots. Citing another study, this time involving more than 600 financial economists, Zweig said 44% believed that markets are generally efficient, while nearly a quarter agreed with the statement “When I invest, my goal is to beat the market.” In effect, he noted, they believe themselves capable of doing better than average despite knowing that the vast majority of people will not be able to.
Research by psychologist David Tucket has also found a tendency among leading portfolio managers to develop “a sense of truth based on narrative,” collecting data and real or apparent patterns into stories that merge “emotion and fact.” Going further back in time, Zweig cited a 2007 survey by the Greenwich Roundtable, a non-profit that educates its members about hedge funds, buyout funds, and so-called alternative investments. In all, more than five dozen consultants and investment officers at endowments, foundations, family offices, retirement plans, and funds of hedge funds responded.
