A landmark 2001 study showed that women outclassed men as investors by nearly 1 percent per year. Now we are coming closer to understanding why: Testosterone interferes with the male investor’s brain.
A new study from Caltech, Wharton, Western University and ZRT Laboratory found that men are quicker to make judgments and less likely to examine facts that might prove them wrong.
Researchers gave two groups of men either a testosterone gel or a placebo. Then they asked questions designed to test their ability to reflect on facts.
For instance, if a ball and a bat cost $1.10 and the bat costs $1 more than the ball, how much does the ball cost?
Most people quickly say “10 cents,” but that’s wrong. The answer is 5 cents for the ball and $1.05 for the bat.
(Consider that 5 cents plus $1 equals $1.05, so the bat must cost more than $1 to reach the total of $1.10. If the ball cost 10 cents and the bat costs $1 more, the total is $1.20.)
“What we found was the testosterone group was quicker to make snap judgments on brain teasers where your initial guess is usually wrong,” says Caltech Professor Colin Camerer.
“The testosterone is either inhibiting the process of mentally checking your work or increasing the intuitive feeling that ‘I’m definitely right.'”
The interesting part is that, much like with investing, there was money on the line during the experiment.
The test subjects were given $1 for every correct answer and additional $2 if they answered all of the questions right. It’s not a startling amount, but behavorial finance researchers know that it doesn’t take much cash to motivate a test taker.
Nevertheless, cash wasn’t enough enticement to overcome the hurry-up drug that is testosterone. Men in the study who got the dosed gel scored 20% fewer questions right than the men who used the placebo.
“We think it works through confidence enhancement. If you’re more confident, you’ll feel like you’re right and will not have enough self-doubt to correct mistakes,” Camerer says.
Scientists hestitate to draw connections between unrelated studies, yet the result suggests that there’s an actual reason why the 2001 study found women to be better at investing than men.
Women do less trading. We know what. Lower testosterone might be the reason why.
Brad Barber and Terrance Odean at the University of California Berkeley, writing in the Quarterly Journal of Economics, found that while women traded, men traded more. That extra trading costs plenty.
In their words, “We believe that there is a simple and powerful explanation for high levels of trading on financial markets: overconfidence.”
In even earlier research, Odean showed that overconfidence, the belief that one understands with great precision the value of a security, led to more trading and, consequently, greater losses.
Sometimes you’re right, sometimes you’re wrong. If you trade more, however, the averages tend to catch up with you. That has a real cost in terms of performance.
Now, 1 percent a year (the study found the gap between the sexes to be 94 basis points) might not sound like much, but it’s huge. In a market where you might expect a portfolio to earn 8%, a steady difference of 0.94% is close to a 12.5% returns gap each year.
Remember, too, that investments compound. Losses today, however small, mean you are missing money that no longer grows for you.
Testosterone trap
A portfolio investment of $10,000 that generates 8% annual returns would become $100,627 over three decades. No additional saving, just compounding returns.
That same portfolio earning 7.06% turns into $77,414. The performance gap here is 23%. You end up with 23% less money just by trading more.
One might conclude that the answer is to hire female financial advisors. At Rebalance, my firm, we absolutely support that notion and have many women advisors on our team.
Yet it’s just as logical to act like a woman investor and choose to tamp down the nasty effects of testosterone on your retirement investments.
By relying on highly diversified, low-cost index funds you kill two birds with one stone: You jettison the extra cost trading built into most stock mutual funds and you eliminate the urge to buy and sell on your own.
By all means, hire a female advisor if you can, but your first step toward retiring with more should be avoiding the testosterone trap by indexing instead.
