Morningstar Advisor - October/November 2009 - 46

Spotlight Reading List To learn more about how people make economic decisions, we suggest: Nudge, by Richard H. Thaler and Cass R. Sunstein (Penguin, 2009). Behavioral Finance and Wealth Management: How to Build Optimal Portfolios That Account for Investor Bias, by Michael Pompian (Wiley Finance, 2006). Why Smart People Make Big Money Mistakes And How to Correct Them, by Gary Belsky and Thomas Gilovich (Simon & Schuster, 2000). Predictably Irrational: The Hidden Forces That Shape Our Decisions, by Dan Ariely (Harper, 2009). Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing, by Hersh Shefrin (Oxford University Press, 2007). Behavioral Investing: A Practitioners Guide to Applying Behavioural Finance, by James Montier (Wiley Finance, 2007). Your Money & Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, by Jason Zweig (Simon & Schuster, 2008). Another thing I would say is that the big problem going forward—especially as I’m the tip of the baby-boom generation and as our generation starts to retire—is that nobody really thinks that they found the solution to how we should handle decumulation. And what’s the right role for annuities? Part of this is behavioral. Most people don’t like annuities. One reason is they don’t like the idea that if they die too young, then the insurance company makes a lot of money. New products need to be invented and new marketing schemes created that will make people comfortable with at least putting some of their portfolio into products like that. One other thing that obviously jumps to mind is what will be the long-term implications of 2008? I suppose that will depend on how quickly the market recovers. The bear market of 2000–03 seemed to have been forgotten pretty quickly. I think maybe it’s because the money that people made came in so fast that it was “easy come, easy go.” Rekenthaler: Or another way of putting it is a lot of the people didn’t really lose money in a sense, they just lost what they had made in 1999 and early 2000. Thaler: Right. We sometimes call that the from what they hear from their customers, is skepticism about the fundamental notion of Modern Portfolio Theory. Because it seemed like everything fell at the same time, people are questioning the point of diversification. And they have an increased desire to find what I would call market-timing strategies. The notion of long-term strategic asset allocation got rocked a bit. Thaler: I think that’s true. Of course, the sad truth is that nobody has ever had much success with tactical asset allocation or market-timing. Even my dear friend Bob Shiller, who was prescient about the Internet and the real estate bubbles, in both cases was early. I remember when I came out to meet with Kahneman and Tversky in ’77, my impression was California real estate was a bubble. I was happy I didn’t have to buy into it then. You can see how smart that was. Nobody has really figured out how to do timing. I remember in the 1990s, advisors told me that they were having a hard time talking clients out of investing everything in technology stocks. It was hard to convince anybody that real estate wasn’t a sure thing. But in some ways, individual investors have come out looking pretty good in all of this. There’s no sense in the data that I’ve seen—at least in 401(k) plans—that there’s been a massive move away from equities. The biggest mistakes and the biggest losses were all made by the professionals. We’ve had entire companies blow up. I think the observation that diversification “ain’t what it used to be” is quite profound, and one that the pros didn’t get. Let’s hope they’ve gotten it going forward. K John Rekenthaler, a former student of Richard Thaler’s, is Morningstar’s vice president of research and new product development. house money effect. You win $1,000 at a casino and then lose it back; you don’t really feel like you’ve lost anything. It was their money. Rekenthaler: I’ve heard it from few advisors, as well. Thaler: Let’s just say they’re human. Rekenthaler: Same thing, right? Thaler: Yes, exactly. I think it’s fair to say that many clinical psychologists spend a lot of time talking to their clients about money and that many advisors think that they’re more of a shrink than anything else. Obviously, the market’s fall in 2000 was concentrated. Nasdaq fell by two thirds, but the rest of the market didn’t get hit so badly. Here, everything got crushed, including real estate. So, I don’t know what the longrun effect is going to be. The next time I talk to a group of financial advisors I’ll be interested in hearing their war stories about this. Rekenthaler: I’d say in the short term, from what we’re hearing from the advisor community, which, of course, is a reflection 46 Morningstar Advisor October/November 2009

Morningstar Advisor - October/November 2009

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