December 12, 2002

Christopher H. Browne Examines Investor Psychology

Christopher H. Browne, managing director for Tweedy, Browne Company LLC in New York, started the NJFPA's first-ever annual fall forum on November 22 in East Brunswick, New Jersey. During his keynote speech examining investor psychology, he discussed how it relates to investment decisions, and how money managers can understand behavioral finance. We spoke with Mr. Browne shortly after his lecture about individual investing habits and the year ahead.

Are there different psychological profiles that investors fall under?

I don't know that it is so clearly defined as different categories, but there are attributes of every investor. It is a question of where they will fall under that spectrum. One is the overconfidence factor. After reviewing over 100,000 trades at Charles Schwab, analysts found that the stocks investors sold did better than the ones they bought. Yet people persist in trading. Obviously, the answer is that investors do it because they think they are making the right decisions, despite the fact that evidence tells them they are not. And it is the overconfidence in information that people receive, whether it's from some financial talk show or some Wall Street analyst. If you will notice that all kinds of Wall Street people make predictions about the market, but no one ever goes back to them a year later and says that they were wrong. So it all gets forgotten. But on the part of a lot of investors, there is a sense that somebody else has a knowledge that they don't have. Why else would we make heroes out of certain people? We hear that so-and-so is buying XYZ; "well, that person is smart, so let me go buy it too." Instead of bothering to figure out investing on their own. That drives a lot of people's decision-making.

The other factor that greatly affects people's decisions is the fear of being out of step. Everybody tries to track the benchmark.

Finally there are the glamour stocks, the ones that are always on the cover of Fortune and Forbes. People think they can't be wrong in owning a great business.

Women tend to do better than men when it comes to investment decisions. Why?

Women do better because they do fewer trades. They generally are not as confident as men, and they don't have the same bravado when it comes to making investment decisions. During the height of the day traders a few years ago, the traders were predominantly male, and there again the women tended to outperform the men.

Why do investors make irrational decisions?

There is a perception among investors that trends will continue. There is this great quote, "every trend goes on forever until it ends," people look at what have been the most recent past performers, the most recent asset class or stock, and they project that into the future. It is the extrapolation factor. Despite the fact that everybody knows the term "reversion toward the mean," they somehow ignore it in making those decisions. Again, it is the risk of being out of step with everyone else that drives people. It is better to lose money where everybody else lost money, than to lose money where everybody else made money. Being the only one to make money when everyone else is losing money doesn't have as much in the way of making you feel good. It's the concept of utility of gain versus the utility of loss.

Should companies really care about the view of their investors?

The answer to that is yes, but the sub-answer to that is what view? I think they should avoid the investor that is there for the hype. Many people are buying into the hypes, and the analyst projections, and the quarterly earnings statements, etc., as opposed to making decisions that are going to benefit them in the long term rather than the short run.

Can the psychological damage to investors from the 2002 economy be repaired?

I'm amazed at how little damage has been done. I would have thought there would have been much greater redemptions in mutual funds than there have been. But they seem to be pretty steady. I remember talking to my dentist a few years ago, and he bought all high-profile funds that now, of course, have all tanked. He said, "Well, that's okay, because it is for my retirement and I still have time to recover." There is this certain degree of resignation among investors, or an unwillingness to admit a mistake. You'd think that with the S&P down 40% from its peak, people would be panicking, but they aren't. It is quite amazing. It might be because that 40% rut is related to one sector: technology.

After delivering bad news to clients in the last year, how can planners recover and reestablish client relations?

It is a question of being honest with clients and not putting a spin on things. But the advisor also needs to think about what they did. If they got caught up in the fad and they lost money because they stayed on the telecom/technology medium bandwagon, they really didn't do their clients any kind of a service. They are the ones that are supposed to maintain a rational view in the midst of fads, bubbles, bursts, and the rest of it. And if they got caught up in it like everyone else, then what are they doing in the business?

Do you have any specific sector predictions?

I think that overall, things are improving, but one of the things affecting companies is a loss of pricing power. That might be to a great extent due to the Internet. You might see something in a store, but you can go on the Internet and find it cheaper. And that includes industrial products and consumer products. It is virtually impossible to fool the consumer by charging more than your competitors charge per product. So the theory for companies to increase prices to increase profits has been stripped away. I don't think that will ever recover; I think companies are going to have to readjust to it.

Other thoughts?

If something seems to be too good to be true, it probably is. You have to be an optimist to be in the investment business, but you also have to be a skeptic. It is very important to have a healthy dose of skepticism and to always look at the downside. Always ask yourself, "What can happen to make this fall apart?" You can't always predict that, but if you focus on that, you avoid a lot of big mistakes. The upside tends to take care of itself.

Staff Editor Megan L. Fowler can be reached at mfowler@ia-mag.com.

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