Why Women Make Better Investors than Men
They have fewer illusions about their skills.
Posted Oct 14, 2015
In a world that has a thousand beatings in store for you every day you get up - as Wally Shawn's character memorably expressed it in the movie My Dinner with Andre - you have two choices. Either you get seriously humble along with Shawn, or you get spectacularly lucky. These options are illustrated by investment differences between men and women.
A Random Walk Down Wall Street
In Burton Malkiel's book of this title (1), the notion that some individuals are good at picking stocks is taken out for a thrashing. Malkiel shows that professional managers under perform the averages substantially so that investors would be better off buying an index fund, that mirrors the performance of the Standard and Poors 500, or some other index.
Of course, many people would point to a successful investor like Warren Buffet as a counter example. Unfortunately for them, Buffet himself is a fan of indexing and advises young investors to buy the index fund instead of wasting their time trying to pick stock winners. No doubt he has read Malkiel and accepted his conclusion.
Nobel Laureate Daniel Kahneman (2) is also a fan of Malkiel and his interest, as a psychologist, is why people persist in believing that they can beat the market when all of the evidence indicates that they cannot. Kahneman believes that there is an “illusion of skill” that is as compelling, and as wrong, as the Muller-Lyer illusion where a line with inward pointing arrows attached is perceived as longer than one the same length with outward pointing arrows.
Kahneman did an analysis of the investment results of 27 wealth advisers by correlating their returns each year over eight consecutive years to see whether advisers doing better in one year would also out-perform in other years.
To Kahneman's surprise, the correlations averaged .01, or essentially zero. He concludes: “The results resembled what you would expect from a dice-rolling contest, not a game of skill.” (2, p. 215)
It so happened that investment returns formed the basis of the company's annual bonuses, so that they were rewarding luck as though it were skill. Interestingly, the advisers themselves continued to take credit for their returns even after it was demonstrated that their differing returns were entirely due to chance.
Gender Differences in Investing
Women are widely believed to be more risk averse in their investing decisions, although we have to recognize that we live in a world where such stable gender differences of the past are becoming increasingly irrelevant. This is no great surprise given that women are (or were) more risk averse in other domains, from participation in dangerous sports, to doing dangerous jobs, driving recklessly, or getting into a knife fight.
Avoiding risk is not always an advantage because risky investments generally outperform less risky ones, at least if investors are not prone to panic selling whenever their positions decline substantially so that they effectively buy high and sell low.
Given their greater confidence in their own investment skills, men trade more frequently, kicking duds out of their portfolio and buying the next brightest idea. This might seem smart in terms of applying a financial version of natural selection to promote survival of the most profitable. What of the evidence?
Results of a study of trading by finance professor Terry Odean (3) of Berkeley are far from encouraging.
Odean analyzed 10,000 brokerage accounts and looked for instances where an individual investor sold one stock and bought another within a few days. Price changes of the stock being sold and its replacement were compared over a one-year period. Shares that were sold outperformed shares that were purchased by a hefty margin of 3.2 percent not counting trading fees.
Subsequent research (4) found that male investors trade much more often than women so that men's results are substantially lower.
So it is really better to be humble and to recognize that the only valuable investing skill is the capacity to sit on one's trading fingers, preferably combined with a talent for sleeping soundly at night.
1 Malkiel, B. (2015). A random walk down Wall Street.
2 Kahneman, D. (2011). Thinking fast and slow. New York: Farrar Straus and Giroux.
3 Barber, B. M., and Odean, T. (2002). Trading is haxardous to your wealth. Journal of Finance, 55, 773-806.
4 Barber, B. M., and Odean, T. (2006). “Boys will be boys.” Quarterly Journal of Economics, 116, 261-292.