Rich and Co.

“Many households avoid investing directly in stocks out of vague fears that they might be deliberately misled or cheated…those who indicated a high level of trust were 50 percent more likely to invest in the stock market. They were also more likely to have diversified their stock holdings. “

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Knowing whom to trust, and relying on those who are trustworthy, is itself an aspect of intelligence. Mr. Guiso and his co-authors cited research that suggested that investment decisions relied significantly on a part of the brain called the Brodmann area 10. This region of the frontal cortex is believed to be associated with our ability to make inferences about others’ preferences and beliefs based on their actions. Such social intelligence seems to reward some people more than others with an ability to put standard investment advice into practice.

Successful investing requires that we judge other people, and it relies on an ability to develop a good model of others’ minds. It requires that we put into perspective recent angry rhetoric against Wall Street and understand that, while some criticisms are surely justified, others are just as surely exaggerated.

Anyone, regardless of background or education, may worry about being misled. The professionals tell us that the stock market is the best place to invest, but such assurances don’t help us when the market swoons. Many pros assured us that housing prices would never decline, either.

But if we can somehow foster more trust in investment professionals, a full spectrum of people — whatever their I.Q.’s — might adopt a more successful approach toward investing.

THE Consumer Financial Protection Bureau created by the Dodd-Frank Act of 2010 and now under the command of Richard Cordray, ought to be an important vehicle to help bring about such trust, by responding to complaints and making rules that will help restore confidence. The Office of Financial Education, one of its divisions, would seem to have a big role in this effort.

The government, as well as those in financial and educational spheres, must think about how we can restore and strengthen ordinary people’s trust in the financial markets. It doesn’t take a high I.Q. to see that it’s in everyone’s interest to get basic financial decisions right.

The paper, titled “Trusting the Stock Market,”[9] was published in The Journal of Finance.


Written by Rich and Co.

March 6, 2012 at 4:17 pm

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