Disturbing Behaviour

“To me, the efficient market is like a game of roulette. It doesn’t matter if you are someone who is playing roulette for the first time or someone who has spent half of your life standing at the table, your chances of winning are the same,” he said, explaining that in an efficient market everything is priced properly and for anyone who chooses to buy a stock, the chances of earning normal returns are the same for all investors.

“But there is another view of markets,” Odean added. “It’s the view that they are like a game of poker.” He explained his analogy stating that in a poker game, people don’t have control over the cards they’re dealt but, professionals who play night after night will likely come out on top compared to those who just play for fun.

The latter is how Odean views the markets and he continued by pointing to specific research he had done that showed individual investors don’t fair as well as institutional investors. He continued to say that investors as a whole typically trade too much—and presented studies to prove that point as well.

Odean summarized the problem of overactive trading to three investor biases: they are overconfident and therefore trade too often, they try to reduce regret by clinging to losers and they are confused about probability and chase performance. “We want people to invest for the long run, buy and hold, diversify, control trading costs, pay attention to taxes,” he concluded.

But Odean’s presentation didn’t just focus on investor behavior. He gave insight into that of DC plan members as well.

As plan sponsors know, it often takes employees more than their probation period to sign up for their DC plan (if it’s voluntary). When they do enroll, they often put their money into the default fund, at the default savings rate. Odean said this is due to hyperbolic discounting (the tendency to prefer smaller payoffs now over larger payoffs later). “People want a banana next week but the chocolate bar today,” he said. So what can plan sponsors do?

According to Odean, research has shown what happened when plan sponsors changed their defaults, and the results were surprising. When plans automatically enrolled members and included automatic increases as their salaries rose, people didn’t opt out and their savings rates went up.

With plan sponsors faced with the possibility of having the overconfident individuals that are constantly trading and those who’d prefer to store their life savings under their mattresses, a happy medium needs to be found.

To comment on this story, email april.scottclarke@rci.rogers.com.