John Howe is Professor of Finance, Missouri Bankers Chair, and Chair of the Finance Department at the University of Missouri – Columbia (MU). He is a Chartered Financial Analyst (CFA) as well as a Governance Fellow of the National Association of Corporate Directors. He has been a visiting scholar at the University of Cambridge (U.K.) and Queensland University of Technology (Australia), and has taught courses for the banking group UBS (Switzerland).
His book, The Foolish Corner: Avoiding Mind Traps in Personal Finance Decisions, is available on Amazon. You can read the Table of Contents, Introduction, and Chapter 1 at: http://www.knowthybiasedself.com/
1. How did you discover your passion for finance and what made you decide to teach?
My father was a professor. I saw his work as encompassing the “world of ideas” in which one can exchange ideas with interesting and intelligent people, in which one can have civilized debates about important issues, and in which research can shed new light on how the world works. He brought this inquiring nature home—there were always ideas floating around the house, so to speak. I also liked what I saw about the lifestyle of an academic.
My passion for finance started in my teen years, when I got interested in the stock market. A (modest) birthday gift of cash was the start of my investing career. I soon discovered the fascinating variety of financial instruments, e.g., convertible bonds, preferred stock of all types, options, warrants, futures, and so forth.
But it wasn’t until I was in graduate school in Economics that I realized that Finance was a separate, rigorous academic discipline. I had always thought about investing as something one did in one’s spare time. The thought that I could rigorously study financial markets was captivating, so now I’m a Finance professor, not an Economics professor (although the fields are very closely allied).
2. Your book, The Foolish Corner: Avoiding Mind Traps in Personal Finance Decisions, taps into a relatively new academic area called behavioral finance. Can you explain what that is and why it’s important?
Behavioral finance challenges traditional economic models of decision making by recognizing the cognitive limitations and biases that we all have. The grandfathers, if you will, of this field are Daniel Kahneman and Amos Tversky; Kahneman won the Nobel Prize for his work in this area (Tversky had died by that time and the Nobel Prize is only awarded to living people). They convincingly argued—and provided evidence—that people are not the rational actors envisioned in conventional economic models.
Precisely because behavioral finance is disruptive, it is important at a number of levels. My book focuses on individual financial decision making, although the topics there do have application to organization-wide decision making. By recognizing and then working to mitigate or offset our cognitive limitations and biases, we can make better financial decisions.
Understanding behavioral finance/economics can also lead to better public policy. Richard Thaler and Cass Sunstein’s book, Nudge, has many examples, including the differential impacts of opt-out versus opt-in option signups for retirement plans.
3. What kind of biases can block smart decisions and what advice would you give our readers to combat them?
One common flaw that we deal with is the tendency to see patterns when in fact there are no patterns. This idea is not new. David Hume wrote, “We find human faces in the moon, armies in clouds…” in his 1889 book, Natural History of Religion. As applied to investing, people look for, and trade on, perceived patterns in stock price changes, when in fact they are largely (although not completely) random. This tendency, along with overconfidence (another bias) leads to unnecessary trading and its accompanying transaction costs. Here the remedy is not to use perceived patterns as the basis of a trading strategy and, more generally, not to trade frequently. For most of us, a well-diversified, low-expense-ratio mutual fund is the right way to go.
Another common bias is confirmation bias, the innate tendency to filter out information that runs contrary to our beliefs and to give substantial weight to information that reinforces our beliefs. One of your earlier guests, Annafi Wahed, wrote, “In a world of a billion news feeds, it’s up to us to seek out opposing viewpoints…” She was referring to the political scene, where confirmation bias is readily evident, but it applies to personal financial decision making as well. For example, many people don’t want to hear that they haven’t saved enough for retirement, when the reality is that a majority of people are not saving enough. It is somewhat like a child putting her fingers in her ears and saying, “Nah, nah, nah, nah, nah, nah.”