Terrance Odean

graphics/terrance.gif

Terrance Odean teaches at the Haas School of Business, University of California, Berkeley. His research on how psychologically motivated decisions affect investor welfare and securities prices has been cited in numerous publications including The Wall Street Journal , The New York Times , The L.A. Times , The Washington Post , Time , Newsweek , Barron's , Forbes , Business Week , Smart Money , Bloomberg Personal , Worth , and Kipplinger's Personal Finance .

Lessons for investors from behavioral finance

Trading is hazardous to your wealth.

In a study of monthly positions for over 66,000 households with accounts at a large discount brokerage, Brad Barber and I found that the twenty percent of investors who traded least actively outperformed the twenty percent who traded most actively by an average of 5.5 percentage points a year. We believe that many active traders are overconfident in their ability to pick stocks.
Before you trade, consult your wife (if you have one).

Consistent with the overconfidence hypothesis, Brad Barber and I found that men - who tend to be more overconfident than women in areas such as finance - traded on average 45 percent more actively than women. Both men and women tended to reduce their returns through trading, but men did so annually by 1 percentage point more, on average, than did women.
If you need to sell, sell for a loss.

When I studied the common stock trading patterns for investors at a large discount brokerage, I found that they are far more likely to sell their winners than their losers. This is backwards . While, in general, investors should avoid active trading, if they need to sell stock to raise cash they should sell their losers - at least in taxable account. In this way, they get a tax write off now and postpone realizing capital gains. If the loss is sufficient, they should consider selling simply to capture the tax benefit. (By the way, on average, those losers don't bounce back. The losers people clung to on my sample subsequently underperformed the winners they sold.)
Do the things you can do, not the things you can't.

Many investors concentrate on picking winning stocks. For the most part they can't. I've found that, on average, the stocks investors sell subsequently outperform the stocks they buy - even before subtracting transactions costs. Most investors would be better off forgetting about picking winners and paying attention to doing the things they can actually do. Controlling trading costs, managing taxes, and diversifying.
When the market is crashing, go to the beach .

Don't make long- term investment decisions in a panic. In a calm moment, evaluate your portfolio. Decide whether your mix of stocks, bonds , and other assets is appropriate for your goals and emotional and financial ability to sustain losses. If you need help figuring this out, get it. This is a much more fundamental decision than which stocks to pick. If a market downturn churns your stomach, go for a walk. When the market, and your stomach, have settled, re-evaluate the risk profile of your portfolio.
Diversify, diversify, diversify.

Mutual funds are the optimal investment for most investors. Buy funds with no-loads, low expense ratios, and low turnover . Index funds are a good choice for many people.
Get 90% of the thrills with 10% of the risk.

If you really enjoy trading common stocks consider putting 90% of your common stock portfolio into mutual funds and treating the remaining 10% as an 'entertainment' account. If you keep the entertainment account small enough that you can comfortable sustain some losses, you can go ride the rollercoaster of risky stocks to your heart's content.
Give your portfolio an annual check-up.

Don't follow your portfolio returns day to day. If you do, short-term market losses may chase you out of the market. If you have an appropriate, well-diversified portfolio, it doesn't need constant tune-ups.