The Difference Between a Normal Investor and a Rational Investor

Behavioural finance provides a realistic and comprehensive framework for understanding financial markets and decision-making. Incorporating insights from psychology, it enhances our understanding of investor behaviour, market dynamics, and risk management, leading to more effective investment strategies and improved financial outcomes. In this episode, Professor Meir Statman, a renowned expert in finance and behavioural finance, takes us on a captivating journey through the intriguing world of maximizing well-being through finance. Professor Statman is a distinguished financial expert and a leading authority in the field of behavioural finance. His groundbreaking research has shaped the understanding of investor behaviour and its impact on financial decision-making. Through his academic contributions and practical insights, Professor Statman has become a trusted guide in navigating the complex intersection of finance and human behaviour. In our conversation, he unravels the secrets of maximizing well-being through finance and the intricacies of the field. We explore the captivating world of behavioural finance and its connection to efficient markets, the distinction between normal and rational investors, the allure of lottery-like assets, and the downsides of consuming dividends. We unpack the aversion to realizing losses and the debate between dollar-cost averaging and lump-sum investing. We delve into the rising popularity of alternative investment strategies, the influence of status on rational investor behaviour, the role of financial advisors, and much more. Tune in for this enlightening conversation that will not only reshape your understanding of finance but human behaviour too.

Key Points From This Episode:

• Defining what behavioural finance is and how it relates to efficient markets. (0:04:37)
• How traditional financial economists responded to Professor Statman's early behavioural work and the current state of behavioural finance research. (0:06:12)
• The various generations of behavioural finance and how they differ. (0:08:51)
• Differences between a normal investor and a rational one. (0:13:10)
• What investors really want and why normal investors like lottery-like assets. (0:15:48)
• Reasons normal investors have a preference for cash dividends. (0:20:17)
• Downsides of consuming dividends and not capital. (0:22:09)
• Unpacking why normal investors are averse to realizing losses. (0:25:40)
• Dollar-cost averaging versus lump sum investing. (0:27:57)
• The popularity of alternative investment strategies to normal investors. (0:31:13)
• Insights about the difference between an error and what a person wants. (0:34:49)
• The influence of status on rational investor behaviour and whether financial advisors should cater for elevating status. (0:36:37)
• Currency hedging, regret, the value of financial literacy, and the distinction between behavioural portfolio theory and traditional mean-variance portfolio theory. (0:40:50)
• Applying the market's portfolio theory to behavioural portfolio theory. (0:49:36)
• Exploring theories through a CAPM lens and behavioural theory's interpretation of return premiums from factors like size and value. (0:50:51)
• The role of financial advisors in correcting behavioural errors of clients. (1:00:16)
• Professor Statman's definition of success. (1:09:25)

Participate in our Community Discussion about this Episode:

https://community.rationalreminder.ca/t/episode-258-prof-meir-statman-financial-decisions-for-normal-people-discussion-thread/23934

Book From Today’s Episode:

Behavioral Finance: The Second Generation — https://amzn.to/3qR7AmM

Links From Today’s Episode:

Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.  Rational Reminder Website — https://rationalreminder.ca/ 

Shop Merch — https://shop.rationalreminder.ca/

Join the Community — https://community.rationalreminder.ca/

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Benjamin on Twitter — https://twitter.com/benjaminwfelix

Cameron on Twitter — https://twitter.com/CameronPassmore

Prof. Meir Statman on Twitter — https://twitter.com/meirstatman

Prof. Meir Statman — https://www.scu.edu/business/finance/faculty/statman/

'Behavioral Efficient Markets' — http://doi.org/10.3905/jpm.2018.44.3.076

'What Is Behavioral Finance?' — https://www.cfainstitute.org/-/media/documents/book/rf-publication/2019/behavioral-finance-the-second-generation.pdf

'Behavioral Finance: The Second Generation' — https://www.cfainstitute.org/-/media/documents/book/rf-publication/2019/behavioral-finance-the-second-generation.pdf

What Investors Really Want — http://doi.org/10.2469/faj.v66.n2.5

Explaining investor preference for cash dividends — http://doi.org/10.1016/0304-405x(84)90025-4

The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence — https://doi.org/10.1111/j.1540-6261.1985.tb05002.x

A Behavioral Framework for Dollar-Cost Averaging — http://doi.org/10.3905/jpm.1995.409537

Behavioral Aspects of the Design and Marketing of Financial Products — http://doi.org/10.2307/3665864

Options and structured products in behavioral portfolios — http://doi.org/10.1016/j.jedc.2012.07.004

Lottery Players/Stock Traders — http://doi.org/10.2469/faj.v58.n1.2506

Hedging Currencies with Hindsight and Regret — http://doi.org/10.3905/joi.2005.517170

Behavioral Portfolio Theory — http://doi.org/10.2307/2676187

Portfolio Optimization with Mental Accounts — https://www.cambridge.org/core/services/aop-cambridge-core/content/view/4B23CFB326982C52014A1BA447FA9244/S0022109010000141a.pdf/portfolio-optimization-with-mental-accounts.pdf

Making Sense of Beta, Size, and Book-to-Market — http://doi.org/10.3905/jpm.1995.409506

Affect in a Behavioral Asset-Pricing Model — http://doi.org/10.2469/faj.v64.n2.8

From Financial Advisers to Well-Being Advisers; Well-Being Advisers — http://doi.org/10.3905/jwm.2023.1.202