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By Christine Benz | 02-24-2012 09:00 AM

Investors Still Living in 2008

The vividness of the 2008 crisis is still influencing investors' decisions today, likely to the detriment of their portfolios, says Santa Clara University finance professor Meir Statman.

Christine Benz: Hi, I'm Christine Benz for Morningstar. I am here at the Morningstar Ibbotson Conference, where we had the opportunity to sit down with Meir Statman. Meir is a professor of finance at Santa Clara University. He is also one of the leading lights in the realm of behavioral finance. We talked about the growth in certain asset classes and what that might say about investor psychology.

Christine Benz: Meir, thank you for being here.

Meir Statman: Delighted to be with you.

Benz: Meir, you focus on the intersection between investor emotions and behavior and their investment decision-making, and I'd like you to opine about a few categories that have recently seen a lot of investor interest, and maybe talk about what they're saying about investor psychology. So for several years running, we've seen very strong inflows into bond funds, and I'm wondering if you can talk about what you think that suggests about investor behavior?

Statman: Well, it suggests two things. One is that the emotions matters, in particular, the emotion of fear. And second, the tendency that we have to extrapolate from the past.

Now, when it comes to fear, God knows, we have reason to be afraid--2008 is several years ago, but it feels like yesterday, it feels like today. It is still more vivid than 2011, and so people are afraid that what we saw in 2008 is going to come again because of Europe, because of other things. So fear is high, and when fear is high, people are risk-averse, and when they are risk averse, they go to bonds even if their yields are minuscule.

Second has to do with extrapolation, and it's extrapolation not necessarily from the past as much as from vivid events. Generally, the immediate past is most vivid, but in our case, people still feel, as I said, that we are in 2008, and so people still think that the world is going to be like that--that stocks are always going to lose, that bonds are their safety part, and that really is going to defeat them.

Benz: And that was such as searing experience that investors went through during that financial crisis, you're saying people would rather take a safe, but low return than risk any money by investing in stocks.

Statman: Precisely. People are afraid. But remember, for most people, taking risk is not a luxury. If you're going to put your money in money market funds, you're going to earn nothing, and after inflation you're going to earn a negative return, and for longer-term bonds, it is not much better than that. So, young people have to take risk, and risk means generally investing some of the money in equities and taking the discomfort that comes with it right now.

Benz: Now, a related category that has seen some investor interest over the past couple of years is precious metals, gold in particular. Last year we had kind of a mania going on for gold. Is that a similar phenomenon? Is that fearful or is that greed or what is that?

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