A researcher at Central Michigan University surveyed 600 finance professors at major universities to determine their investment philosophies, practices, and the differerences between the two. You would think that those involved in higher education, teaching about market analysis, options and futures, and discounted cash flow analysis, would use these techniques when handling their own investments.
Apparently, most don’t.
About two-thirds of the professors, in fact, have the bulk of their assets in index funds, the low-cost baskets that essentially own the entire market. These academics more or less practice the basic lesson of modern portfolio theory: Diversification is the key to holding down your risk and maximizing your returns. That leaves a third who have gone astray, however.
So what about the remaining third? Surely these professors analyze the details of every stock they own and will know before buying the relevant information to determine the company’s chance of increasing its value. Again, this group of professors ignores their own advice as well, preferring to make purchasing decisions on recent performance. That is, they chase the hot stocks, too.
Of the portion of professors who believe in the “efficient market hypothesis,” which says that a stock’s price already takes all information into account, about 25% still believe they can beat the market by timing its fluctuations. They believe that the market cannot be timed — unless by them.
I don’t expect all professors to follow their own advice at all times. After all, they’re training their students to be finance professionals, fund managers, and analysts. In many cases, the professors are not finance professionals, they are professors. They’re not paid for their trading skills, they’re employed for their teaching skills.
What Really Matters When Buying and Selling Stocks? [James Doran and Colbrin Wright]
Don’t try to invest like the pros [Money Magazine]
Published or updated February 1, 2008.
{ 7 comments… read them below or add one }
I’m kind of surprised that so many invest in index funds. But they probably spend their whole day teaching about stock analysis, so to go home and look over stocks would probably be the last thing they want to do.
I think they invest in index funds because they know better. I learned all about portfolio theory and buying stocks, bonds, commodities, and other investments to diversify and enhance returns. It’s one thing when it’s other people’s money, but quite a different approach to attempt at home. The professors know that they could spend a lot of time creating a portfolio that is more likely to underperform the index with similar levels of risk.
I think the 25% who don’t utilize index funds fall into the first trap of behavioral finance: overconfidence. Those investors who attempt to beat the markets all believe they are smarter than other investors. And, I imagine these folks suffer from overconfidence even more than most market timers. The professors have advanced degrees and teach business so they must really think they have an advantage.
Of course, academic research shows they don’t.
I’m with Dan. I bet they know how hard it would be to really time the market, analyze stocks, all that. And the low odds of doing it really well.
Plus they probably spend so much time teaching, grading papers, etc. My husband doesn’t even teach a full course load…and he wouldn’t have time to really keep on top of the market if he wanted to.
“Diversification is the key to holding down your risk and maximizing your returns.” – could be misunderstood. Diversification minimizes risks (uncertainty), but it does not change returns. Modern (Markowitz) portfolio theory is eminently academic, so I would actually expect all of them to follow it. Note that there are several versions of the efficient market hypothesis. These guys probably believe in the weak form which popularly speaking assumes that the market is composed of clever people as well as stupid people and that the stupid people sometimes dominate the price (like buying houses they can’t afford of dot.com stock at P/E’s in the 60s .. ).
Note the word “hypothesis”. In order to get anywhere in a soft science like economics one has to make assumptions. The idea of instantly correctly priced securities is a big assumption but once you make it, the math becomes solvable and presto, we can make a precise theory. However, just because a theory is precise does not mean that it is accurate.
I rant I rant .. but I completely agree with your last sentence.
To be fair, the old joke is that if you are very good investing in single pick Commodities ,you can…lose your money much slower then the average investor!
do as I say not as I do!