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Better Investing Through Science?

Christine Benz

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

I'm here today at the Wall Street Journal's office, and I'm joined by Jason Zweig. Jason is personal finance columnist for the Journal, and he's also author of several books about money and investing.

Jason, so nice to see you. Great to be here with you.

Jason Zweig: Thanks, Christine. Thanks for coming.

Benz: So, Jason, you're always up-to-date on the latest in the realm of academic finance, and the latest literature about what the academics are seeing and saying.

What are some studies that you've come across recently that have piqued your interest?

Zweig: Well, I think, there are a couple of areas that are very new and exciting, Christine. One that I've been sort of paying a lot of attention to out of the corner of my eye is what's come to be called genoeconomics, which is a study of essentially how our DNA interacts with our financial decision making, and scientists have already identified several genes that seem to be implicated in controlling impulsive behaviors.

So that down the road one of the hopes is that if people can come up with perhaps a drug treatment or a behavioral treatment, you may be able to identify people who have a genetic predisposition toward being impulsive, for example. So that you may eventually get to the point where you can help people save for the future and set aside their impulsive reluctance to set money aside.

This could be a huge breakthrough although this kind of research generally takes many years to pay off and it's still in very early stage, but down the road, I think, we'll be able to help people either with drugs or therapy who have a variety of financial dysfunction.

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Benz: So this is kind of an extension of some of the things you talked about in your book, Your Money and Your Brain, but that was talking about how your brain interacts with financial decision making.

I know that you are a huge fan of the area of behavioral finance, and there have recently been some policy changes that have actually implemented behavioral finance findings. So automatic investment plans, or automatic enrollment and then automatic increases. Are you happy with what's happened there? Do you think that's the right direction for behavioral finance to take?

Zweig: Yeah. I think so, I think there too we're still early in the evolution or the revolution of incorporating behavioral economics into public policy and financial decision making in general. It is starting to penetrate. One of the areas where still a great deal needs to be done is probably outside the realm of investing per se, and that would be in saving and spending behavior. The example I just gave about people with a genetic predisposition not to save is a very clear example.

There also is a lot of emerging evidence on how credit card behavior can be improved for people's overall well being. And just yesterday I saw a study showing that people will spend substantially more on junk food if they pay for it with their credit card than if they pay for it with cash, which, when you think about it, makes perfect sense because when you take your credit card out of your pocket or out of your purse, we use the term we're whipping out our credit card. And it does feel impulsive and instantaneous, and of course you don't pay the bill for another 30 days at the least, whereas if you pay cash, you feel the pain of paying right away. And so paying cash is an act of thinking twice and saying to yourself, wow, if I take this $20 bill out of my wallet and put it on the counter, it's gone.

And that hesitation may itself sort of turn you from French fries to –

Benz: An apple.

Zweig: – an apple.

Benz: So, a related question is, I know that you are a fan of indexing, but you are also a big believer in this area of behavioral finance. So, how do the two coexist? So, if there are these behavioral inefficiencies to be exploited, why should you index, why not think about picking some stocks because maybe investors are making poor behavioral decisions about them?

Zweig: Well, first of all, I think that's a wonderful question, Christine, and my take on it sort of falls in between. My feeling is that, if investing were purely an economic activity, then it would never make any sense for anyone to do anything other than buy an index fund--but it's not purely an economic activity.

Highly intelligent people buy lottery tickets, and know they're not going to win, and they buy them anyway because there's actually an economic value in hope. Hope is valuable to people, and investing in individual stocks or buying actively managed mutual funds is entertaining, it's fun, people enjoy it.

Benz: Not always, but…

Zweig: Well, it can be. I should say, it can be. It hasn't been so fun for a while for a lot of people, but over time, certainly it has been fun and entertaining.

And if you say to people, why are you doing that? That makes no sense; only idiots do that. You are not only being a killjoy, but you're also being very naïve about human nature. And people want to have some fun, they want to enjoy themselves.

And the way I would view it is if you index most of your money, then there's not only no harm in picking a handful of stocks yourself, but it also certainly is educational. It's very engaging for high school students or college students for example as a way to become more involved in the economy, and if you confine the amount of money you commit to that strategy, you also confine your potential losses, and you're likely to be a much happier investor than if you attempted to do nothing but keep your money in index funds, and at the worst possible time, you either got completely out or jumped entirely in, which is what behavioral economics really tells us you'd be likely to do.

Benz: Right. Right. Well, thank you, Jason, always great to hear your insights. I appreciate it.

Zweig: Thanks, Christine. My pleasure.

Benz: Thanks for watching. I'm Christine Benz from Morningstar.com.