During the euphoric 1999 market bubble, behavioral finance professor Terrance Odean — standout grad student of Nobel-winning psychologist Daniel Kahneman — urged overconfident investors not confuse brains with a bull market.
Today, Odean's message to nervous investors, fretting that the eight-year bull will soon collapse: Don't be a market timer — most individual investors are bad at it, he told ThinkAdvisor, in an interview.
Investors typically fail at market timing because they exit too late and, likewise, re-enter too late, Odean says. Rather, clients should now be huddling with their financial advisors to structure a plan for if and when the market drops precipitously.
Odean, who teaches finance at the Haas School of Business of the University of California, Berkeley, made waves with groundbreaking research showing that investors sell winners — wrongly, except in December for tax-motivated selling — and, wrongly, hold on to losers. Selling for a gain makes people feel good, he notes. Selling for a loss prompts feelings of regret.
Other Odean research, conducted with Professor Brad M. Barber, found that men trade more than women, thereby hurting the former's returns. Women were "less bad" at investing than men because men think they know more about investing than they actually do, his study titled "Boys Will Be Boys" showed.
Odean, 66, is now researching cognitive decline in older investors as well as the lack of women in financial-industry jobs such as money manager, analyst, mutual fund manager and financial advisor, though, he says, the gender gap is narrower for FAs than for the other categories.
ThinkAdvisor recently spoke with Odean, a laudatory reference for whom Kahneman sat penning while waiting to learn if he'd won a 2002 Nobel, Michael Lewis writes in "The Undoing Project." As a Ph.D. candidate, Odean co-owned a Pacific Stock Exchange seat and flirted with becoming an options trader. But "the thought of spending years standing in a crowd of shouting people didn't appeal to me," he allowed, in an earlier interview with this reporter. Here are excerpts from our most recent conversation:
THINKADVISOR: Is there a basis in reality for investors to feel anxious about an impending market cash?
TERRANCE ODEAN: There's some potential for disruption. The probability of the unexpected seems higher than it had with the previous administration. So it doesn't seem out of the question that President Trump would do something that will scare markets.
So what should investors be constructively focused on?
How will the decisions that are made, erratic as they might be, affect the ability of U.S. and international companies to continue to earn profits, and how will these decisions affect the overall American economy?
How can investors who are frightened protect their investments right now?
If the markets do take a big dive and will cause you a lot of anxiety, and make you want to sell, it's better to trim your portfolio back now. You never want to be making dramatic moves, in either direction, when you're feeling scared. People are better off trying to keep strong, intense emotions out of their investment decisions.
Alternatively, what could they do with their portfolio?
If an investor feels that the market is oversold or that the potential for something really bad happening is high, they could consider changing their asset allocation but not make big shifts.
But since it's been such a long bull market — and a record-setting one — some experts say we're indeed cruising for a bruising. Therefore, many investors are considering getting out now.
It's possible to be somewhat successful with market timing. But what I've seen is that, by and large, when individual investors engage in market timing, they get things wrong. They tend to get out too late and get back in too late. It would be excessive to completely get out of U.S. stocks right now. An investor who thinks that something will rattle the market could scale back their equity holdings.
But what about those who feel their best bet is to go to cash?
