134 Finance for Normal People with Dr. Meir Statman

Jason interviews Dr. Meir Statman.

Meir Statman is the Glenn Klimek Professor of Finance at Santa Clara University. His research focuses on behavioral finance. He attempts to understand how investors and managers make financial decisions and how these decisions are reflected in financial markets. His most recent book is “Finance for Normal People: How Investors and Markets Behave,” published by Oxford University Press.

The questions he addresses in his research include: What are investors’ wants and how can we help investors balance them? What are investors’ cognitive and emotional shortcuts and how can we help them overcome cognitive and emotional errors? How are wants, shortcuts and errors reflected in choices of saving, spending, and portfolio construction? How are they reflected in asset pricing and market efficiency?

Meir’s research has been published in the Journal of Finance, the Journal of Financial Economics, the Review of Financial Studies, the Journal of Financial and Quantitative Analysis, the Financial Analysts Journal, the Journal of Portfolio Management, and many other journals.  The research has been supported by the National Science Foundation, the Research Foundation of the CFA Institute, and the Investment Management Consultants Association (IMCA).

Meir is a member of the Advisory Board of the Journal of Portfolio Management, the Journal of Wealth Management, the Journal of Retirement, the Journal of Investment Consulting, and the Journal of Behavioral and Experimental Finance, an Associate Editor of the Journal of Financial Research, the Journal of Behavioral Finance, and the Journal of Investment Management and a recipient of a Batterymarch Fellowship, a William F. Sharpe Best Paper Award, a Bernstein Fabozzi/Jacobs Levy Outstanding Article Award, a Davis Ethics Award, a Moskowitz Prize for best paper on socially responsible investing, a Matthew R. McArthur Industry Pioneer Award, three Baker IMCA Journal Awards, and three Graham and Dodd Awards.  Meir was named as one of the 25 most influential people by Investment Advisor. He consults with many investment companies and presents his work to academics and professionals in many forums in the U.S. and abroad.

Meir received his Ph.D. from Columbia University and his B.A. and M.B.A. from the Hebrew University of Jerusalem.

Below is the full transcript:


Announcer: Welcome back, America, to Sound Retirement Radio. Where we bring you concepts, ideas and strategies designed to help you achieve clarity, confidence and freedom as you prepare for and transition through retirement.

 And now, here is your host, Jason Parker.

Jason: America, welcome back. Of course, I’ve been sitting here reading my jokes, preparing for you this morning, trying to pick out just the right one for you to share with your kids and your grandkids. So here you go:

 Why couldn’t the pirate play cards? Because he was sitting on the deck.

 Folks, you’re listening to Episode 134, you’re gonna love this episode. I’m gonna be bringing Meir Statman on the program in just a minute to talk about behavioral finance. Before I do though, as you know I like to get the morning started right by renewing our mind. And so I’ve got a verse here for us, this one comes from Matthew 23:12 and says,

 “For those who exalt themselves will be humbled, and those who humble themselves will be exalted.” That’s Jesus’ teaching.

 All right, so let’s dive into this. Episode Number 134. Meir Statman, he’s a professor of finance at the Leavey School of Business, Santa Clara University. He has his PhD from Columbia University. His research focuses on behavioral finance. He attempts to understand how investors and managers make financial decisions, and how these decisions are reflected in financial markets. His most recent book is ‘Finance For Normal People: How Investors & Markets Behave’, published by Oxford University Press.

 Meir Statman, thank you for being a guest, welcome.

Meir: Delighted to be with you, Jason.

Jason: This is gonna be a good one. You know, the reason this interview came about, I happened to be reading an article in the Wall Street Journal that was titled ‘The Mental Mistakes We Make With Retirement Spending’. This was an article that you had written and it caught my attention so I appreciate you being on here because at Sound Retirement Radio, our specialty is retirement planning.

 I want to start out today asking you about your book, your new book. Why did you write it?

Meir: Well I wrote it of course because I had something to say, and what I had to say is that we had, still have, standard finesse, or people who are described as rational. And in what I call the first generation of behavioral finance, we describe people as irrational. Describing so many of the cognitive and emotional errors that we are all subject to, and that is all true. Except that we have lost people along the way. That is, people are normal, neither rational, neither computer-like rational nor bumbling irrational, we are normal with normal wants. And so we have to begin with those wants. We have to begin by understanding what it is that people want, such as hope for riches, protection from poverty, caring about children and grandchildren, being socially responsible, having high starters and so on. If we understand what it is that people want, we can go from there to help them make better financial decisions.

Jason: So, behavioral finance and the fact that we’re emotional beings, emotional creatures, is there … If there was just one area that you see people making mistakes when it comes to their money, when it comes to their retirement, what’s the biggest mistake people make because of emotions, behavior?

Meir: Oh, fear I think I think is one of the emotions … Again, fear is in us by evolution or by creation for good reason. Fear means that when the car in front of us on the highway stops suddenly, we press hard on the brake pedal before we have a chance to evaluate what is really going on. Fear prevents us from stepping too close to the edge of a roof. But fear can be excessive, and fear for example causes all the people, and younger ones, to for example jump out of the market when markets turn south. And that is something that people should be aware of. Fear causes retired people to be excessively cautious of spending, expecting to live to 120 and so they live like misers even if they have ample financial resources.

Jason: You know, in your article as I was reading it, the mental mistakes … There were three things that you said. Sometimes these mental mistakes can cause us to spend too little, spend on the wrong things, or take too much investment risk. So let’s talk about each one of those three, so spend too little. You think that Americans, you think we have a spending problem? It seems like we don’t have any problem pulling out the debit card these days.

Meir: No, the discussions about spending and saving are very, very skewed. That is, we talk about the need to save. Of course there is a need to save, we talk about people as if there is just one group and we talk about a retirement crisis. But the thing is that there are poor people, there are middle class people, there are upper-middle class people, and then there are wealthy, and advice must be different for each of them. A lot of people, even if it’s a small percentage of the population, has in fact saved so much during their working years that they find themselves accidentally wealthy. And suddenly they look at millions of dollars, and they might be in their 70s or 80s, and then question really is what you do. This is a different problem from somebody who is in his 20s and has to save such that he or she will be accidentally rich when they are 70.

Jason: It’s an interesting phenomenon. I have the opportunity to talk to people all over the country on this retirement question and it is fascinating to me that just saving more money and having more doesn’t necessarily give people a greater sense of confidence that they have enough. It’s frequent that I speak with people that have saved two million, three million dollars and they’re concerned, “Do we have enough?” Their lifestyle tends to increase as their assets have gone up.

 But, one of the things you said that I wanted to come back to, on the mental mistakes. You say, “spending money on the wrong things,” what are wrong things? What are wrong things? What would be an example of a wrong thing to spend money on in retirement?

Meir: Well, actually I don’t know if there are wrong things. There are things that matter to us, and so what is wrong for one is right for another. For example, if you advised me, and I’m 70 now, if you advised me to go on a long cruise I would jump off that boat surely before mid-course. So that is that for me. Don’t ask me to go to a fancy restaurant where dinners are $200 or $300 with some fancy wine because I would feel like an idiot being taken advantage of. But if you ask me, would I fly business class on long overseas trips? Well I just did that, because I am sufficiently old and sufficiently well off to afford that and at this point it really makes a lot of sense for me. If you ask me, is it right for me to spend a lot of money on charity organization causes that matter to me, that is right by me. And so people should figure out what is right for them, rather than kind of have this sort of general thing, spend money. I say spend money that brings you more joy than pain.

Jason: I read that, I liked that. Learn to spend on what brings us joy. And I think those are some great examples.

 Folks, if you’re just tuning in I have Dr. Statman on the program with us, he’s Professor of Finance at Santa Clara University. His new book is ‘Finance For Normal People: How Investors & Markets Behave’. A lot of his research is on behavioral finance.

 In this article that you had written for the Wall Street Journal, Dr. Statman, you talked about better ways of prudent spending and you gave two examples, one being a managed payout fund, and the other one being the required minimum distributions. Talk to us a minute on why you think it might be helpful for people to come up with this type of spending plan.

Meir: The mental rules that we set for ourselves when we save are very effective in promoting saving. In particular, we divide money into what is income and what is capital and we follow a rule, a self-control rule, that says spend income but don’t dip into capital. That makes a lot of sense when you are saving for retirement because it prevents you from selling your investments and spending the money. But when you get to be retired, just living on the income … Say that you have $2 million dollars in stocks, then with a dividend yield of 2% it gives you $40,000 a year. Well, if you are in your 70s or 80s, how long do you think that you will really live? Have you looked at the obituaries lately? And so it is really time for you to figure out ways that make it easier for you to spend capital.

 Now, managed payout funds … What they do really is they send you a check or deposit that feels like income, but in fact it is composed of income such as dividends as well as controlled dips into capital. The same is true for the RMD. You know, that is, when you get your RMD lots of retired people take the RMDs, they are mad at the government for imposing taxes on them, and then deposit it back. Well, think of the RMD as your income and feel free to spend it now that you have paid taxes on it anyway.

Jason: Hmm, that’s good.

 Let me ask you about budgeting, because one of the things that we know is that if you don’t have any idea how much money you spend it’s really hard to answer the question of have you saved enough, and it sounds like you’ve done really well in life, accumulating assets. Do you have any tips for our listeners on what you’ve learned by budgeting, or how you budget, or what that looks like for you?

Meir: People have different kinds of budgeting. Some people have Excel sheets where they have assets and liabilities and profits and loss, and they go about it in a very precise way. I don’t. I can see my balance in my money market fund go up or go down, and I have in the back of my mind how much money is taken for 41K or 43B in my case. And so I would not impose strict budgeting on people who can do that more intuitively, and then if people want to do it more structurally that is fine with me as well.

Jason: And I want to back up to your point about people thinking that they’re gonna live to be aged 120, because obviously you have to know how much money you’re spending to be able to answer how much … have you saved enough. But then the other piece to that equation is how long are you gonna live? And you’re right. A good friend of mine, his mom had lived to age 102, his health was excellent. We all thought he was gonna outlive his mom, and then cancer hit and at 79 he was gone. So do you have any tips for people … I know in your article you referenced the mortality tables that social security uses. Do you think that’s a reasonable estimate for how long people are gonna live? Or do you think people with medicine, science, technology, should people be planning on living longer than the mortality tables?

Meir: Yeah, I think the mortality tables are average, and my point is this: if you are really concerned that you’re going to live to 120, then buy an annuity. Buy an immediate annuity when you’re 70 or whatever it is and then you are sure that you are going to get income for life, even if you live to 120. But people hate annuities. And so it suggests to me that this story about people don’t want to spend because they might live to 120 is really an excuse that people have for not spending. I think that what really happens is that, as we moved from pensions to defined contribution savings, people kind of find themselves un-moored, and they really don’t know how to manage their spending, where in pension, you get your check and you spend it and there is another check next month.

 And so this combination of the reluctance to buy an annuity and this fear of outliving your money suggests that people perhaps, and I can see that, people just like the feeling of having a lot of money, which gives them a sense of satisfaction and security. I know that that is true for myself, I know that I feel good knowing that I can buy a Rolls Royce if I wanted to but I don’t want to. That is different from wanting to buy a new car and being unable to afford it. And so people should think about that reasonable lifespan and of course should leave a good amount as reserve, for example people usually keep their home equity and they hope to leave it for the kids. But if they happen to live to 102, they will have to … or they have the option of having a reverse mortgage.

Jason: So this is interesting because if the purpose, if the reason that people saved for retirement in the first place is so that they’ll be comfortable in retirement … And really, what they’re saying is they want income in retirement, they want income from the portfolio. But you brought up this fact that people hate annuities. I know people in the academic community like annuities because they provide guaranteed income. Why do you suppose that everybody just doesn’t take all of their retirement savings, go plunk it into an immediate annuity and just get the maximum income and just have that guaranteed pension? Why do you suppose people hate annuities if they’re designed to accomplish income, which is what people want in retirement?

Meir: People want more than income in retirement. People want wealth, and it really feels good to have wealth. And remember, ask yourself why would somebody who has $2 billion dollars want $3 billion dollars? It’s not because he is homeless, it is because it is status, it is … People care about their social status and we measure social status, to some extent at least, by the kind of wealth that we have. And so, what people want is not to be poor, and in this sense they want income so that they can pay for groceries and even go to concerts and so on. But people also want to be rich, and that means to have a large portfolio and a sense of, “I can buy a Rolls Royce if I wanted to.” And we have to attend to both of those needs.

 Many people have wills where they say they have no kids and so they leave it to the university where they studied, really not because they like that university so much, but that is kind of the default. They know that they cannot take it with them, so they leave it to university because that seems to be a reasonable thing. And so if we understand what it is that people want, it’s an addition to money for groceries, they also care about starters and they also care about their children and grandchildren. Then we can spend money better, for example, giving money to kids and grandkids early rather than having them wait until you die. When kids need to go to college, when grandkids needs to go to college and parents might not have the means to actually pay tuition, well grandparents often have more than enough. Why not use it when it is useful rather than live to be 100 and leave it to your 80 year old son?

Jason: That’s interesting. I like that, in your article you talked about the joy of giving from a warm hand versus a cold one, where you never get to experience the joy of seeing how those gifts help people. And I really like that.

Meir: Yeah there is, you know, I came from Israel as you can hear in my accent and culture is different. We got help from our parents and we are expected by culture to help our children. American culture, or at least some American culture, has sort of a severe sweet tooth, that to get people to be responsible you really have to deprive them of things so that they will really appreciate that.

 I was never felt that I was deprived of anything and yet I did not grow up to be a spendthrift. This kind of stuff, it feels like toilet training for grown-ups. So parents should be generous with their kids. If you can afford to pay college tuition, pay it rather than make them work many hours so that they will learn the value of money. That just is more than stupid, it really is disruptive for families.

Jason: That’s really an interesting take. My experience was, my dad was really adamant about working hard and I remember I had my first lawn mowing business when I think I was 11 years old. And I did learn those lessons of having to go out and not get anything. I remember when I moved out of my house after college, my dad came up as I was driving my car up to Alaska to put on the ferry. He came out and he took a silver dollar and he pressed it into the palm of my hand, the silver dollar was the year that I was born and he said, “Jason, this is for when times get tough.” He said I never had to go home and ask for help, and so this for when times get tough. And I have to tell you, it meant a lot to me and it really made me put my nose to the grindstone. So, different life experiences but the results are the same. So, you know and I both are enjoying prosperity as a result of our family upbringing.

 I wanted to ask you about diminished consumption beyond age 70, because one of the things you talked about in your article is that maybe people won’t be spending as much later in life as they are in their early parts of retirement. Will you take a moment and speak about that?

Meir: Well sure, I mean when people die … Houses of people who lived in them until they died at very advanced age, they invariably have to renovate them. Not just replace the furniture because they don’t like the style, but it is likely that the kitchen is shoddy, that the furniture is worn out, that there are many needs to renovate the bathrooms and so on. It is because old people kind of say well, you know, the furniture, it’s still there and I can still sit on the chair. They just don’t look at that as something what they needed to make those changes. I can see it in myself you know, that there’s … I just drive the car that I’ve driven for many years, I don’t feel the need to replace it and so on.

 And then when people get to be older than 70 as I am, as they get to be in their 80s and 90s then travel, even in business class, gets to be a problem and the … And when, God forbid, but it happens, a spouse dies, then the joy of traveling abroad or going even to a restaurant diminishes. So, people spend less when they age and people should know that you are not going to enjoy things in your 90s that you can enjoy when you’re 70.

Jason: Dr. Statman, thank you for being a guest on Sound Retirement Radio.

Meir: Thank you, wonderful to be with you, Jason.

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