Mind on My Money

How to invest wisely

Taxes – What We Want

The desire to avoid taxes can drive silly investment choices.

There is much talk about taxes these days.

Should we extend the Bush capital gains tax cuts? Should we extend them for the middle class and let them expire for the wealth? Should we close the massive federal budget deficit through higher taxes? What do we want?

Meir Statman knows what we want. We want to pay no taxes.

It was anger over taxation by Briton that caused American colonists to toss a shipload of tea overboard in protest at the Boston Tea Party. The current political Tea Party movement also appears upset about taxes.

In fact, we can get a little silly when it comes to want to avoid paying taxes. For example, a retailer can get more attention by advertising a Sales Tax Holiday than by advertising a ten percent discount. The retailer simply pays the seven percent sales tax for the customers, which is cheaper than giving the ten percent discount.

In Meir's new book What Investors Really Want, he describes what drives our investment decisions. When thinking about our investments, we want to increase our wealth (called utilitarian benefits). But we want much more than that! We also want our investments to convey who we are (called expressive benefits). We are often willing to pay more for investments like hedge funds because they say that we are smart, sophisticated and have status. Lastly, we also get emotional benefits from our investments. Some make us feel safe, others excited. We feel proud of our successes.

Meir tells fascinating tales of the trials and tribulations that people go through in order to avoid or even evade paying taxes...including planning the timing of their own death! The desire to pay no taxes may be cultural. Tax evasion is common and normal behavior in Greece, but rare in Denmark. (Note that Denmark's government is fiscally sound while Greece flirts with bankruptcy.)

Over time, various investment tax shelters have been pitched to investors. While their marketing advertises a good investment return (utilitarian benefit), these investment really sell because of their expressive and emotional benefits. Buying these shelters expresses that we are smart and sophisticated, while the tax avoidance makes us happy. Unfortunately, we get seduced by the expressive and emotional benefits and do not spend enough time analyzing the utilitarian. Many of these investments have given poor returns, like the real estate partnerships of the 1980s, or failed to fool the IRS, like the offshore strategies of the 2000s.

I highly recommend Meir's book. It is a terrific read and it really describes how what-you-really-want affects your investment choices—often in strange ways.


Reference: Meir Statman, What Investors Really Want: Know What Drives Investor Behavior and Make Smarter Financial Decisions, McGraw-Hill, 2010.

John Nofsinger is the Seward Chair and Professor of Finance at the University of Alaska Anchorage and a speaker, writer, and scholar on behavioral and socially responsible finance.

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