omists have been trying to figure out why stocks have returned so much
more than fixed-income investments. Studies show that over periods of
20 years or more, a diversified portfolio of equities not only offers higher
after-inflation returns but is actually safer than government bonds. But
because investors concentrate on an investment horizon that is too short,
stocks seem very risky and investors must be enticed to hold stocks with
a fat premium. If investors evaluated their portfolio less frequently, the
equity premium might fall dramatically.
Bernartzi and Thaler have shown that the high equity premium is
consistent with myopic loss aversion and yearly monitoring of returns.
But they also showed that if investors had evaluated their portfolio allo-
cation only once every 10 years, the equity premium needed to be only 2
percent to entice investors into stocks. With an evaluation period of 20
years, the premium fell to only 1.4 percent, and it would have been close
to 1 percent if the evaluation period were 30 years. Stock prices would
have had to rise dramatically to reduce the premium to these low levels.
Dave:Are you saying that perhaps I should not look at my stocks too
frequently?
IC:You can look at them all you want, but don’t alter your long-term
strategy. Remember to set up rules and incentives. Commit to a long-run
portfolio allocation, and do not alter it unless there is significant evi-
dence that a certain sector is becoming greatly overpriced relative to its
fundamentals, as the technology stocks did at the top of the bubble.Contrarian Investing and Investor Sentiment:
Strategies to Enhance Portfolio ReturnsDave:Is there a way for an investor to take advantage of others’ behav-
ioral weakness and earn superior returns from them?
IC:Standing apart from the crowd might be quite profitable. An investor
who takes a different view is said to be a contrarian, one who dissents
from the prevailing opinion. Contrarian strategy was first put forth by
Humphrey B. Neill in a pamphlet called “It Pays to Be Contrary,” first
circulated in 1951 and later turned into a book entitled The Art of Con-
trary Thinking. In it Neill declared: “When everyone thinks alike, every-
one is likely to be wrong.”^28
Some contrarian approaches are based on psychologically driven in-
dicators such as investor “sentiment.” The underlying idea is that mostCHAPTER 19 Behavioral Finance and the Psychology of Investing 333
(^28) Humphrey B. Neill, The Art of Contrary Thinking, Caldwell, Idaho: Caxton Printers, 1954, p. 1.