Here’s a controversial thought: men and women are different.
Not in terms of strength, temperament, intuition, or any of those things—not for the purposes of this article, anyway. They’re different in terms of how they invest.
A spate of studies looks at gender-based financial behavior. One finds that women tend to be more involved in the family balance sheet. Just over 60% of women manage the household checkbook; 58% pay the bills; 44% (versus only 23% of men) oversee the budget.1
Yet only 15% of married women take primary care of the family investments. This in spite of the finding that, when it comes to choosing investments, women tend to be more diligent. Surveys suggest that while men chase “hot” stocks and mutual funds, women spend almost twice as much time researching mutual funds before investing. This could be due to greater caution on the part of women, or, depending how you look at it, greater hubris on the part of men. A ShareBuilder survey reports that 12% of women versus 21% of men feel “confident” about their investment abilities.
Whatever the cause, it pays off. Finance professors Brad Barber and Terrance Odean find that—though women hold less risky portfolios than men, pursuing (and expecting) lower returns—after adjusting for differences in risk, women achieve bigger returns.
Before we giggle or grunt, let’s make a larger, gender-neutral point: Overconfident investors trade too much. Indeed, Barber and Odean take pains to assure us that gender is but a convenient statistical tool—”a variable that provides a natural proxy” for the real factor at work, overconfidence. Psychology researchers have long held that men are more prone to overconfidence, so we’d expect them to trade more aggressively. We’d also expect this trading to increase costs, which in turn should reduce performance. To test this, the authors set out to determine if the population that is naturally overconfident earns lower average returns than the population that isn’t. (See? It’s not about men and women at all!)
The professors analyze a huge database of brokerage accounts from the 1990s. They find that married men trade 45 percent more than married women and earn annual risk-adjusted net returns that are 140 basis points lower. Moreover, the differences widen when the sample isn’t married people: Single men trade 67 percent more than single women and earn annual risk-adjusted net returns that are a full 230 basis points lower. Worse still, the men have average turnover of 77% per year(!) while the women have average turnover around 53% per year (it seems both groups need advisors instead of brokers).
If you believe the stereotypes, these results shouldn’t surprise you. Men are supposedly brought up to embrace competition and risk. This translates into winning short-term sprints, not waiting out marathons in broadly diversified strategies. Sure, research is great, but guys don’t like to ask for directions. Women, on the other hand, are more likely to avoid knife-fights, Scotch, or taking a flyer on some dicey stock or hedge fund. The research shows they’re also more likely to seek out data and expert help, and to take their time before committing assets.
It also turns out that non-experts of either sex tend to make investment decisions poorly, and too often. We see this in the returns of retirement accounts: Defined Benefits (DB) plans run by professional investors historically outperform Defined Contribution plans in which participants call the shots—and by about 200 basis points per year.2
It’s hard to blame the participants. Pension platforms are usually salad bars that, if anything, stress fund selection and not asset allocation. And while companies might provide education to participants, they rarely offer the tools available to professionals. Where DB plans use Monte Carlo simulations, optimizers, and multifactor models, such methods are unavailable to DC participants, and would be perplexing-unto-useless if they were. After all, most participants already have jobs. A retirement plan might offer the best education program in the world, but how many participants have the time or inclination to moonlight as the next Warren Buffett?
You might reasonably think the returns differences between DC and DB are fee-based: DC plans offer mutual funds, which, pound-for-pound, charge greater fees than separately managed DB trusts. Unfortunately, that’s just the start. DC plans tend to favor active funds, which usually charge more than passive funds. You might not view this as a distinction either, since DB plans also favor active managers. But to the extent employees are left to decide which funds to choose, they’re likely to base their choices on recent performance, which would lead investors into funds that have higher average fees even by active management standards.
When DC plans first got legs in the 1980s, participants were risk-averse. As late as 1990, DB plans held 60% of assets in equities while DC plans held only 45%.3 Following the last couple of bull markets, this changed: DC participants jacked up their equity exposure. The key word here is “following.” Leading into the 2008 market meltdown, 401(k) plans held upward of 70% of total assets in equities. It’s tough to escape the conclusion that they “under-invested” in equities right before bull markets and “over-invested” in equities right before bear markets. We can debate whether expert advice would have helped (after all, “experts” populated the DC plans with expensive active funds to begin with), but the data suggest that DB plan allocations were more stable through the ups and downs of the last two decades.
Like practicing law, investing is a skill. Laypeople should no more manage their own portfolios than defend themselves in court. In the investing skill-set, two traits that clearly pay dividends are patience and knowledge. Whether they know it or not, most people benefit from prudent, professional advice. Gender and plan studies reinforce the role of advisors and sponsors, with a few added insights:
When both partners are involved, a family’s portfolio can benefit. As a broad generality, men might be more amenable to taking the risks necessary to meet goals, while women might be more amenable to a non-active investment philosophy, appreciate its pedigree, and value the broad diversification of a global strategy. Both traits motivate and bolster investors through good and bad markets. They’re a winning combination.
Investors benefit from an approach that maximizes expected return for appropriate levels of risk. Multifactor investing directly addresses this task. Advisors and sponsors that embrace its tenets are better equipped to help investors avoid the pitfalls of emotional trading. Sponsors can structure pre-allocated options and risk-assessment tools for DC plans. Advisors can do likewise for clients, and those with suitable businesses can consider adding smaller DC plans to their client rosters.
In all cases, a multifactor framework helps resolve the age-old conflict between our impulse to take risk and our desire for prudence and scientific authority. In the end, people of both genders become better investors.