February 1, 2013

KNOWING WHAT YOU DO NOT KNOW . . .

Posted in Behavioral Finance, Financial Planning, Investments, Women and Money at 5:33 pm by Iris Mack Dayoub

Apple for Blog

According to the Bible, hunger for knowledge is what got Adam and Eve into a heap of trouble.  One bite of the apple and so began the bad dream that has tormented us ever since:  namely, finding ourselves trying to explain ourselves to the Boss when we are stark naked.

Unfortunately, not much more was heard from the first couple after their exile.  It’s only now, many millenniums later, that social scientists are discovering that the acquisition of knowledge may have affected the original man and woman in very different ways.   The field of behavioral finance suggests that Adam left the Garden of Eden with a superabundance of confidence, whereas his formerly domineering wife began to seriously doubt herself.

A 1997 study by Beyer and Bowden found that women are less confident about what they know relative to what can be known. Their confidence crisis becomes particularly acute when the “domain is male-oriented.”

Finance, and investing in particular, is certainly one such testosterone-rich domain.  Male investment advisors outnumber female advisors by as much as 4 to 1.  Male investors are more active than women investors, spending more time on security analysis, trading more, and expecting higher returns than do women.  In contrast, a majority of women in a 2005 Merrill Lynch survey said they preferred to spend as little time as possible managing their investments.

But here’s a surprising fact: for all their aversion to investing, women may, in fact, be better at it than men!  A University of California study in 2001 showed that women’s risk-adjusted investment returns beat men’s by an average of 1 percent as a result of their inherent caution.  They trade less, require more information before they invest, and are more apt to learn from their mistakes

Confident investing is critical to women’s financial security.  Their longer lives and lower earnings mean that their portfolios must work much harder than men’s.  Investment success does not – contrary to what most women think – require mastery of vast amounts of technical information, but knowledge of a few basic facts: 

  • Markets are fundamentally risky: no one can know for sure how investments will perform.
  • This risk creates opportunity for higher returns.  A wise investor seeks to manage this risk rather than eliminate it.
  • It’s also prudent to admit that you are not smarter than the next guy or gal.  Once you’ve accepted the fact that you are just an average investor, the idea of average returns begins to make sense.  These returns are available with mutual funds designed to replicate the performance of the broad markets or sectors.  In other words, they do what the market is doing, not more, not less.  But over time, they do a lot better than the individual investor who shoots for the rafters, or hides out in “safe” investments.
  • By being average, and holding average investments, you avoid high expenses, but more importantly, above-average losses.

Ironically, knowing what you don’t know may be the smartest investing strategy of all.   This awareness should inspire more women into taking more risk and becoming more engaged, active investors, as opposed to keeping them on the sidelines.  They don’t need to invest like men to succeed in this male-dominated arena.

Investing like a girl will do just fine.

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