Meir Statman has had a distinguished career studying the way that real people make economic decisions. His new book walks the reader through a litany of the reasons that many investment and financial decisions go awry.
From wanting profits that are wildly in excess of the risks taken to giving up profits in order to avoid taxes, real people all over the world engage in a variety of irrational financial behaviors. Professor Statman provides countless examples of these and cites a dizzying number of research studies that demonstrate the mental errors that we tend to make.
For example, people believe that they can become better investors by joining an investment club, yet the average investment club annual return actually lags the return of the broad stock market. Bidders who take part in eBay auctions hope to get a bargain, but final bids in many such auctions exceed the open market prices of the same goods. And many people who owe credit card balances choose to keep significant amounts of cash in low-yielding bank accounts instead of using the money to pay off their high-interest card balances.
For the astute reader willing to change his or her behavior, Statman’s book is a diagnostic gold mine. My main criticism of the book is that it offers few suggestions that would help the average person make a useful change in behavior. A very disciplined person could certainly take the information presented and use it to develop rules for making more rational financial decisions, but most people are unlikely to be willing to make that effort. Professor Statman’s book is a wonderful romp through the various kinds of mental errors that all of us make, but readers hoping to find ready cures for their bad investment habits may be disappointed.
Full disclosure: I was given a free review copy of this book.