Study Explores What Investors Are Really Thinking

By Roberta Kwok

Economists have developed many theories to explain how people determine the fraction of their money to invest in stocks. But disentangling which theories are correct has been difficult.

“It is a central question of finance,” says James Choi, a professor of finance at Yale SOM.

In the past, researchers typically examined data on, say, stock price movements and tried to deduce investors’ motivations. They often didn’t take what might seem like an obvious step: to ask people what they were thinking. “There’s a feeling among economists that talk is cheap, and what we really care about is people’s actions,” Choi says.

But Choi thought he could still learn something from talk. “I wanted to go back to just asking ordinary people, ‘Hey, do these theories we’re spinning ring a bell at all to you, or are we barking up the wrong tree?’”

In a new study, Choi and a colleague surveyed about 1,000 Americans about their investment decisions. The responses provided evidence for many theories: for instance, as some finance researchers have postulated, people worried that a rare economic disaster would decimate their finances. Some factors—such as concerns about unemployment, illness, and liquidity—seemed to play a bigger role than researchers thought. And some participants said they feared that advisors or firms would bamboozle them.

“There’s a lot of confusion and discomfort,” says Choi, who collaborated with Adriana Robertson of the University of Toronto, a graduate of Yale Law School and Yale SOM’s PhD program in finance. “They don’t like thinking about their finances. They have a hard time trusting people in the market.”

Read the study: “What Matters to Individual Investors? Evidence from the Horse’s Mouth”

The researchers found participants through the RAND American Life Panel, which provides a fairly representative sample of adults in the United States. Among a group of 1,013 people, 59% said they invested some money in the stock market. The team then asked respondents which factors affected the fraction of their portfolio in stocks or their decision to avoid the stock market altogether.

One theory postulates that fear of an economic disaster drives people’s decisions about investments. The survey responses bore that out: 45% of the group said this factor was very or extremely important. “People are really afraid that there’s going to be a second Great Depression,” Choi says. Some economists have expressed skepticism that such concerns play a large role in investment decisions, but “this feels like a more direct piece of evidence.”

Researchers also have tended to assume that worries about getting sick, injured, or laid off would have a fairly small effect. But 42-47% said those factors were key. “Respondents are saying, ‘No, this is actually pretty important to me,” Choi says.

The survey revealed some concerns that had been largely neglected by finance theories. Nearly half of participants seemed worried that stocks were not liquid enough to meet day-to-day cash flow needs. “This is something that’s not really on the radar screen of finance researchers,” Choi says. Considering that it usually takes only a few days to get money out of a brokerage account, his impression had been that “it’s not that big of a deal,” he says. But perhaps people don’t realize how quick the process can be or are living so close to the financial edge that those few days are crucial.

The team also tried to figure out why 41% of survey respondents didn’t invest in stocks at all. Researchers have speculated that people may refrain from participating if they don’t have enough money to make the process worthwhile. The survey responses provided insight into specific roadblocks: Many people seemed to find it too onerous to learn about the market or to find and pay for an advisor.

And among all respondents, 37% said they worried that they couldn’t trust investment professionals. Finance researchers have postulated that the main risk people face is the possibility of getting poor returns, but the survey suggests “there’s something beyond that that people are afraid of—that an advisor or firm is going to run off with their money,” Choi says.

The survey also provided some evidence to support various other theories for investment decisions—for instance, that people are afraid of even small losses and believe that stock market returns are predictable. In the research world, “there’s a desire to convey the message that a single theory is the theory of everything,” Choi says. But the results suggest that the truth is a mishmash of factors: “Many of these theories will combine to explain the phenomena we see out there.”

Finally, the researchers tested people’s knowledge of investment concepts. About half of participants who invested in actively managed mutual funds said they did so because they thought those funds would outperform passive funds, even though the evidence suggests the opposite. And many people didn’t seem to know that value stocks (those that are priced low relative to profits) tend to perform better than growth stocks (those that are priced high relative to profits).

The survey method does have limitations. People may have forgotten why they invested in stocks or be unwilling to admit the real reasons. So Choi advises taking the percentage values with a grain of salt. But the relative rankings of each factor are still informative, he says.

His team is now conducting a similar survey with Americans who have at least $1 million of investable assets. “When it comes to a lot of financial market outcomes we care about, like prices, it’s the behavior and beliefs of the wealthy that are going to have the most impact,” he says.