The course and Professor Odean’s view are informed by his nontraditional background. He conducts one of the lessons in a yoga pose and strums his guitar in another. Vanguard recently spoke to Professor Odean about how investors can benefit from his lessons.
I felt I had an opportunity to possibly help some people with their personal finances. I certainly can’t solve the problem that wages have been stagnant or that tuitions just keep going up and up. But there are things that people can do that can improve their personal finances, or avoid making bad decisions that take a lot to recover from.
What made you decide to offer the course online?
What I’m hoping to do with this course is be fairly pragmatic and hands-on about basic personal finance things. I’ll give you an example from my own life. If you watch my course, you’re going to see that I strongly urge people to buy and hold well-diversified, low-cost index funds, either open-end funds or ETFs (exchange-traded funds).
What would you like to accomplish with the course?
Yet, 30 years or so ago, I had some savings, and I thought: “Well, I should invest in the stock market.” A friend introduced me to his stockbroker. I’m buying and I’m selling, and I’m selling and I’m buying. I think I’m a smart guy, but I wasn’t investing smart. And why not? I simply didn’t know what I should do and so I copied what other people I knew were doing. I hope that some students taking my course can benefit starting off on a good investment track rather than learning from their own, often costly, mistakes.
One topic I discuss in my online course is the importance of simple financial products. When products are complex, they’re hard to understand, and it’s hard to figure out if you’re getting a good price. I really encourage people to look for simple, understandable products. Index funds are simple and easy to compare. Term life insurance is simple and easy to compare.
I talked earlier about how I traded stocks actively before I went back and finished my education. Most of my research has been on the behavior of individual investors. When I got started, I would reflect a lot. The first paper I wrote was about overconfidence and overtrading. I thought about how I had traded so much and how I was I so sure that I was right. That’s why I wrote about overconfidence.
How does your colorful background inform your work and research in behavioral finance?
The second paper I wrote was about holding onto losers and selling winners. I reflected back on my own experience, and realized I had done both of those things. I found it very hard to sell something for a loss and much easier to sell something else for a gain. It felt to me like that’s probably what most investors do. Sure enough, it is. I was able to document this by analyzing actual investor trading records. So I think I did benefit from having had a little life experience before I started doing my research.
Individual investors who actively trade common stocks tend to make trading errors. Many investors don’t realize that they are trading against a professional or against a computer that belongs to and was programmed by a professional. Even though the investor might be smart, the professional investor is also smart, has been trading for years, and isn’t doing so in his or her spare time. For the professional, this is a full-time job, working with a team, and with access to a lot of information.
How are investors their own worst enemy?
Investors are their own worst enemy when they say, “Oh, I’m going to beat the professionals at their own game in my spare time.” It’s not that surprising that people don’t do well. As in my own case, many investors suffer from a lack of understanding and some overconfidence.
As an investor, you should buy and hold; don’t be an active trader. You’ve got to diversify. That eliminates a tremendous amount of risk. Keep your fees low. Fees are like the underside of the iceberg, often ignored but a real danger when it comes to long-term investing. Paying attention to fees will leave you with a lot more money in the long run. And, finally, in your taxable accounts, you should pay some attention to the tax consequences of your investment and trading policies.
Save More Tomorrow isn’t my idea. [Behavioral economists] Richard Thaler and Shlomo Benartzi came up with this, and it is a great idea. People say you should save more, but what if you can’t live on anything less than what you have right now?
What does it mean to save more tomorrow?
There are various ways to implement Save More Tomorrow. The variation I tend to recommend is to commit that the next time you get a raise, you’re going to put half your raise to savings and continue to do that every time you get a raise until you get up to your target saving level.
Saving more tomorrow doesn’t have to be when you get a raise nor does it have to be half of your raise. It could be the whole raise. This is a strategy that will help get you to where you want to go relatively painlessly.
The long-term rise in the market is not for sure. There is risk. If there were no risk whatsoever, then the potential reward would be a lot lower. When you invest, especially if you buy an all-market index fund, you’re basically investing in the economy. For a U.S. fund, you’re investing in the U.S. economy. Of course, most people should also diversify internationally.
Why should we believe that stocks will continue to go up in the long term?
There is some risk that over the next 30 years the economy won’t continue to grow and produce. But very likely, it will grow. The alternative at the other end of the risk spectrum is to buy Treasury bonds or inflation-protected Treasury bonds. However, for many young people, investing only in Treasuries can be risky because doing so is just not going to give enough of a return to provide enough money in retirement.
I think that as people get closer to retirement they should dial down the risk in their portfolio. How much risk you can take also depends on how much wealth you have.
All investing is subject to risk and the possible loss of the money you invest.
Diversification does not ensure a profit or protect against a loss.
Professor Odean’s views are not necessarily Vanguard’s views.