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So what can you do with a science degree?

Meet science grad Hersh Shefrin, Mathematics major, [B.Sc. (Hons)/70], Mario Belotti Chair, Department of Finance, Santa Clara University, Leavey School of Business

June 11, 2015 — 

When it comes to investing money in the stock market, there’s a strange phenomenon that happens with individual investors. People who buy stocks that end up losing money tend to hold on to those stocks. As for the stocks that make money? Rather than keep these lucrative investments, people tend to sell them.

Hersh Shefrin thought this was bizarre some 30 years ago and decided to investigate further. He published a research paper on the subject, The disposition to sell winners too early and ride losers too long: theory and evidence, in 1985. He called it the disposition effect, and the theory has gone on to become one of the most studied aspects of individual investor behaviour.

“People try to avoid regret by holding on to losers and to generate pride by selling winners,” says Shefrin, the Mario Belotti Chair in the Department of Finance at Santa Clara University’s Leavey School of Business in California.

The problem is so common that brokers have developed a way to convince investors to dump bad stock, says Shefrin: investors are told to transfer–not sell–their assets.

Shefrin studies this and other fascinating conduct as a behavioural economist. Beyond all of the endless models and dizzying terminology that surround our analysis of why the stock market is rising or an economy is tanking, there’s a very obvious and at times overlooked fact: we humans are behind it all, and sometimes we do strange, paradoxical things.

“The ego is really important,” says Shefrin.

Shefrin first became interested in economics at the University of Manitoba. His uncle, Frank Shefrin, was a well-known agriculture economist for the Canadian government who for years had encouraged him to try economics. At first, however, young Hersh was more interested in physics.

“At his urging and to mollify him, I took economics as an elective,” says Shefrin. “I was captivated.”

It was the 1960s and his teacher had recently attended the University of California, Berkeley.

“I found that very appealing as someone in their late teens coming out of North End Winnipeg,” recalls Shefrin. “He fired me up and got me interested in social activism. I sort of fell into what I do because of my interest in social issues more than money, per say.”

Shefrin completed a bachelor of science, (Honours) in economics and mathematics from the University of Manitoba; he went on to complete a master of mathematics from the University of Waterloo, and his doctorate in economics from the London School of Economics. Eventually he made his way to Santa Clara University. There, along with writing about the disposition effect, he pioneered an economic theory of self-control based on neurological and psychological factors.

This was a new approach; until then, traditional economists assumed people were rational when it came to economic theories. Shefrin, on the other hand, argued people’s brains weren’t monolithic but rather multi-layered: part of our brain wants everything now and struggles with self-control while another part of our brain is better able to plan for the future.

“This look into human behaviour is more similar to what Freud might have suggested than fellow neo-classical economists,” says Shefrin, who went on to publish Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing.

Today, Shefrin travels around the world to speak at finance conferences and universities about his research. He enjoys learning from these events as much as those listening to him do.

“The learning usually flows in both directions, and I love it that way,” says Shefrin.

One of the few occupational hazards of his work is subconsciously analyzing the financial behaviour of those around him. He also gets asked by journalists and professional groups for financial advice, but less so from friends and colleagues.

“It’s rare for people to ask me for stock tips now as they know to expect me to lecture them on the importance of a passive investment strategy,” says Shefrin.

Despite his research involving the disposition effect, Shefrin still has faith in investing in the stock market. He says that over the long term, it’s actually a nice deal so long as investors have perspective and can stomach the roller coaster ride.

“Even over five year horizons, stock market returns are typically pretty good relative to most alternatives,” says Shefrin.

Interestingly, an increasing percent of those returns are due to stock trades conducted autonomously by computers. Shefrin believes we humans won’t become irrelevant any time soon, however. These programs have a history of creating flash stock market crashes, and Shefrin says our brains—emotional as they may be—are still better at tasks like judging new information coming in to the market.

“It already takes a supercomputer to teach a computer how to play chess well, and chessboards only have 64 squares,” says Shefrin. “I think a human touch will always be needed, and we’ll never really be able to escape our imperfect psychology.”

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