Brad Barber is a professor of finance at the U.C. Davis Graduate School of Management, where he also directs the school’s Center for Investor Welfare and Corporate Responsibility. His research, which focuses on analyst recommendations and investor psychology, has been covered extensively in the financial press, including Business Week, Time, the Wall Street Journal, ABC News, NBC Nightly News, CNN, CNNfn, and CNBC.
Dan Richards interviews Barber at the American Economic Association conference in early January.
A video of this interview is available here.
You co-authored a paper, with your colleague Terrance Odean, All That Glitters: The Effect of Attention in News on the Buying Behavior of Individual and Institutional Investors, that was awarded the Best Conference Paper by the European Finance Association in 2005. Where did the idea for this research come from?
We have been doing a lot of work on the psychology of individual investors. One of the things that seemed to be important to us was the way media portrays different stocks or different companies. The idea was that when the media covers a particular company it focuses investors’ attention on the stock. The observation that we made was that this really is about buying behavior, because many individual investors only hold a few stocks.
When individuals buy a stock, they have many thousands to choose from, but when they sell a stock they only have a handful of stocks that they own in their portfolio. Our hypothesis was that investors are going to be net buyers of stocks that get into the news.
One of the novel things is that the prediction really applies to both good and bad news, because even when you get bad news, an investor can spin a contrarian story: “Now is a time to buy XYZ company, even though it has been beaten down.”
So your thesis was that individual investors are influenced by news. How about institutional investors?
We felt institutions would be less so, because they have systems in place. They have resources available to them that would allow them to, first of all, better filter or process this news. But they also have bigger portfolios, so if there is an attention effect going on it is likely to be much more symmetric with respect to buying and selling behavior for institutions. With individuals’ small portfolios, the attention effect is not going to be as pronounced among the stocks they sell.
What did you find?
We found exactly the patterns we predicted. We looked at this a couple of ways. We looked at news coverage of companies. We actually got press releases for companies and headline stories in major newspapers. What we found was that the more a company was in the news, the more investors tended to be buying the stock.
We measured that buying behavior by looking at data from retail and brokerage firms and found a very robust pattern. Investors tend to be buying “in the news” stocks, even if the news is bad. So, individual investors also tend to be net buyers of stocks when there is bad news about them.
Were you able to take this one step further and evaluate whether investors were well served by the disproportionate tendency to buy stocks in the news?
In this paper, we looked at how those purchases did subsequent to the date of the transaction, and we found that there was very little evidence that those investors had good security selection ability. In fact, there was some weak evidence that these stocks underperformed.
Actually, there is an economic reason why you might expect that to be the case. Imagine a story comes out, and it funnels a lot of attention towards Apple, to pick on a company. You might imagine that creates temporary buying pressure on the stock that will subsequently subside and lead to negative returns. We found some evidence consistent with that story, but to be fair, it was only modestly significant.
So, if you are going to pick individual stocks, it pays to be a contrarian.
It does pay to be a contrarian, and this is a theme economists have been seeing for quite some time, going all the way back to Keynes. It does certainly make sense to ride against the tide, if you will.
I’d like to talk about a paper that you and a couple of colleagues published in July of 2010, Once Burned, Twice Shy: How Pride and Regret Affect the Repurchase of Stocks Previously Sold. Where did the idea for this article came from?
Basically, the idea is simple. It's the notion that one's emotional experience with stocks effects how he or she views subsequent opportunities. There are some very simple insights. For example, if you touch a burning stove, you tend not to touch that stove again – thus the title of our paper.
The simple idea was that, more than the expected returns or variances that economists talk about in determining how investors think of stocks, we felt emotions mattered. And the way in which we looked at that is by looking at how investors choose to purchase the stocks that they have had previous experience with.
How did you gather that data?
We looked at data from 1991 to 1996 from a large discount firm and data from a standard retail brokerage firm in a more recent time period. These were actual trading records of investors who were managing their own portfolios.
Someone has bought a stock at one point, sold it again, and they could have a couple of different kind of experiences. They could have made money. They could have lost money. Did you see a difference in terms of their subsequent behavior, based on whether they lost or made money the first time around?
Absolutely. We were studying how investors’ emotional experiences affected things. Obviously, if you bought a stock and you sold it for a gain, it is a great emotional experience. You feel like you are a wonderful investor. If you bought a stock and sold it for a loss, you don't feel so great about it, and probably want to put the experience behind you.
What we found was that, subsequent to the sale, investors were much more likely to buy a stock again had they previously sold it for a gain. The story that we tell is that if you've had a good experience with a stock you are more likely to revisit that stock in subsequent purchases. In fact, it was very rare in our data set that folks come back to buy a stock that they have sold for a loss.
What if someone sold a stock, but then the stock subsequently went up or down? Did you see a difference in investor behavior in those cases?
Absolutely. And again, our story centers on emotions. So imagine you sold a stock, and imagine that after the sale it goes up tremendously. Well, you are not going to feel very good about buying the stock again because you've missed out on that appreciation, having previously sold the stock.
On the other hand, if you sell a stock and it goes down, you might look and say well, I was really good at timing the sale of that stock, and it is a good opportunity to repurchase the stock. That is exactly what we found. In other words, if they sell a stock and the price goes down, investors are much more likely to buy the stock again than if they sell a stock and its price continues to go up.
Were you able to quantify the experience of those investors?
The details are in the academic paper of course, and we try to make sure that our story is the right story. One of the competing stories is, maybe the investors who sell stocks for a gain are smart. They know how to time the market well, and they buy the stock again when it's down. They are really informed.
In order to discount that potential explanation, we had to look at how an investor’s purchases and sales did subsequent to the date of the transaction. In general, we found that these investors don't have any market timing or security selection ability. The stocks that they subsequently purchase after they have gone down in price don't do any better than buying an index fund, for example. So it doesn't look like these investors are informed, but rather it's just an emotional reaction to the price path of the stock that leads them to buy the stock again.
Based on this analysis and research, what is your advice to investors?
My advice has been the same for the last decade: Buy well diversified, low-cost index funds as a core of your portfolio. I think the profession is very much on the same page on that.
Most of my research centers around the emotions and psychology in investing, and in fact those things get in the way of doing what seems to be a sensible thing – have a well diversified portfolio, hold it, don't spend a lot of time thinking about it, and enjoy your life.
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