Editor’s note: This article was first published in September 2013; the news it reports concerns the 2013 MacArthur Fellows, and the grant amount it cites (625,000 dollars over five years) is that year’s figure.
The MacArthur Foundation has handed out its “genius grants”, a type of fellowship under which Professor Colin Camerer and his project colleagues will receive 625,000 dollars, paid over 5 years.
Camerer’s creative work has become very popular for calling most investors idiots. To do so, he used neural data to test his theory about how these investors behave.
Camerer’s theory is nothing new: it is a very common mistake among investors that we have warned about on several occasions, but human nature makes us fall into it again.
The phenomenon found in Camerer’s study shows how investors (beginners and veterans alike) are very prone to taking their gains in the short term while holding on to their losses for the long term. Naturally, this wrecks the return on an investment portfolio, because we let go of winning stocks and keep the losers. This behaviour seems to be present in about 70% of the investors Camerer analysed.
What leads investors to follow this bad strategy?
Basically, fear. When investors see their shares go up in value, they prefer to take the gain before the stock turns around and starts losing money. On the other hand, when a stock is showing a loss, investors hold on to it in the hope that it will rise again and give them a profit.
As a rule, this strategy ends badly: a high percentage of the stocks we sold keep rising, and the ones we kept, ironically, keep falling. The truth is that it is probably the most absurd behaviour in investing, but I can say from my own experience that sometimes, even knowing this, we do it again.
And I don’t think it is down to investors’ irrationality. I would venture to say that it comes from a bad strategy within the investment itself. Once we realise that the most profitable way to invest in the stock market is for the long term, we usually make better choices when picking stocks, and rather than simply sitting on losing stocks, we invest again (averaging down) to buy shares at cheaper prices, as long as we have studied the company properly.
So if an investor has only gone in to speculate over the short to medium term, then perhaps it does make sense to call them an idiot. I have been an idiot in that sense a few times, especially selling shares with a 90% gain and missing out on an extra 400% because I sold too early. These things happen.
Colin Camerer is a professor of behavioural economics at the California Institute of Technology and graduated from Johns Hopkins University in 1977. (You can read more about Camerer and his work in the Los Angeles Times.)
Further reading
