Richard Thaler's Rip Van Winkle approach to investing

Ring your broker before you go for a long sleep and tell him to put the lot in equities. Merryn Somerset Webb talks to author and behavioural economist Richard Thaler.


Richard Thaler: "The less attention people pay, the better they're going to sleep"

Ring your broker and tell him to put the lot in equities. Then forget about it, relax and sleep well, says Richard Thaler.

Two years ago I gave a talk at a super high-powered event on how the financial industry can regain the public's trust. My advice was pretty simple ("be trustworthy"), but along the way I discussed financial education. I don't rate it much: when it's time to get a mortgage, no one will remember what they were taught about mortgages at school. So skip the finance bit, and just teach maths better.

This modern heresy caused sharp intakes of breath all round (some of the UK's loudest advocates of financial education were there) and I felt a tiny bit embarrassed. But in the break, one of the first people to come up to me was Richard Thaler. "I agree with you," he said.

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Now I know it isn't normal to have economists as heroes. But Thaler was (and is) one of mine. So I was thrilled. When I met him again last week, I reminded him of our conversation and asked if he still felt the same. He does. The real point, he says, is not "whether we should be teaching high-school students about interest rates and compound interest, because obviously we should. The question is whether we think it's going to solve any problems, and the answer is that it won't.

The problems people face in real life are so hard that the things you could teach them in high school, or even college, are not going to help much." He sometimes asks audiences what they remember of their school chemistry lessons. The answer (assuming they aren't all chemists) is "basically nothing". So will teaching them about compound interest help "20 years later when they're ready to buy a house? Probably not." Instead, you need "just-in-time education and simple products... Make it simple."

This brings us to the influence Thaler has had on the UK government (and hence the rest of us). His co-written book, Nudge, which explored how behavourial finance can be used to push people to behave in certain ways, was a hit with George Osborne and David Cameron. Pension Wise, the government pensions guidance service, is a clear example of just-in-time education giving people the information they need just before they make a decision and our new auto-enrolment pension system is, as Thaler notes, heavily influenced by behavioural economics.

It isn't mandatory, but everyone is enrolled unless they actively opt out. Sceptics, says Thaler, were convinced this wouldn't work. But with opt-out rates under 10%, it has. So this is all about inertia, I say. We are too lazy to set up our own pensions but also too lazy to opt out if someone else does it for us. "Yes."

All for freedom

We move on to Osborne's UK pensions freedom revolution. Subject to your marginal tax rate, you can now withdraw your pension money at will from the age of 55. Thaler sees this as "a work in progress". He is "all for freedom" (phew). But people aren't all going to do the best thing for themselves. Taking it all out to go on a cruise isn't the best idea. But nor is just spending the income and leaving the capital intact. In a high-interest, high-dividend environment that might work, but "when interest rates are low, and dividends are out of fashion, thenpeople have to spend the money down. That's what they saved it up for."

I tell him that spending capital is a hard sell in the UK. The financial industry is geared up to help people accumulate, not decumulate (a totally different skill).It knows how to help people build money up (while taking a whopping cut), but not so much about helping them run it down (this used to be left to the insurance companies, via the annuity system). And the other problem with pensions freedom is stress.

Volatile markets mean nothing to those with annuities. But they might be a huge worry to those in control of their own pension cash. Thaler agrees. Individual investors suffer hugely from a mix of panic and overconfidence. They have "a knack for buying high and selling low" which is why they tend to underperform even the funds they are invested in, by about 1.5% a year. And the more they focus on the markets, the more they trade and the more they lose.

What should they do instead? Simple, says Thaler: they should see as little information on the markets as possible be it in newspapers, magazines, or on TV. After a little persuasion, he agrees that MoneyWeek, with its focus on long-term and value investing, is acceptable reading. But we are both clear that investors "should not turn on one of those cable financial news networks that's on 24/7".


That brings us on to Thaler's book, Misbehaving, which has a chapter that should be of interest to long-term investors. In it he discusses the "equity risk premium" the excess return that investors in shares theoretically get over bond investors to compensate for the fact that equities are considered more risky than bonds. Thaler reckons it is higher than it should be people think equities are riskier than they actually are.

Yes, there is huge short-term volatility, which people mistake for long-term risk. But there has also "never been a 20-year period when equities didn't go up or didn't outperform bonds". Put a Rip Van Winkle to sleep for 20 years and the rational thing for him to do before he drops off is to "call his broker and say put it all into equities'... The less attention people pay, the better they're going to sleep, and ironically, the more money they'll have."

I wonder if he practises what he preaches. He is, after all, one of the principals of a fund-management firm Fuller & Thaler. He does. "I couldn't name a security that we own", but he can, however, be sure what kind of stocks they are: the main fund is a value fund. Thaler's belief in value investing goes back to the first finance article he wrote. In it, he went back to 1926 when the data begin "and, for each five-year period, looked at the stocks that had gone down the most, and the stocks that went up the most, formed portfolios, watched them for the next five years, and looked to see what happened". It turned out that the ones that had gone down the most outperformed, and the ones that had gone up then underperformed.

This might not be "a viable investing strategy in and of itself", says Thaler (rather disappointingly). But "it does illustrate the idea of investor over-reaction". After trailing the market for a few years, a company can just get a reputation as a "bad" company "almost like stereotyping". This was once true of Apple: no one would think of buying it, on the basis that it was sure to go under. Now "it's just the opposite it's a company that can't possibly do anything wrong and obviously neither of those views is correct." That's where a good value investor or contrarian finds opportunity perhaps as the chief financial officer of a company that everyone is sure is "bad" starts adding its shares to his personal portfolio.

The big picture

Having established that fund management isn't really that hard as long as you have the personality for it we talk fees for a few minutes. Thaler is a believer in low annual fees combined with well-structured performance fees. I'm a believer in low annual fees only. We then pass by passive management. Thaler's retirement income (which will come via his university) is all in passive funds, of which he thoroughly approves, given the low fees. "Everyone should invest their money either in index funds or in the funds managed by Fuller & Thaler." That seems reasonable to me (particularly as a retirement strategy for Thaler), so we move on to macroeconomics.

Thaler ends his book by saying that he hopes that the next generation of behavioural economists takes on macroeconomics, an area that is currently as model-driven as finance once was. He wants answers to questions about how low interest rates really make people behave, for example. What if they terrify people into saving, rather than galvanise them into spending? If we were clearer on this kind of thing, it "could easily change the way policymakers think".

This stuff is hard to measure we can't know for sure how a different monetary policy regime would have played out and, as Thaler says, no one has had much luck persuading different governmentsto behave in different ways to give academics clear case studies. Fiddling with interest rates is harder than fiddling with pensions. But there is hope: Federal Reserve chief Janet Yellen, who Thaler counts as a "friend", is into behavioural finance she has co-authored a few papers on it with her Nobel Prize-winning husband George Akerlof.

So in the hope that Thaler might have some insider knowledge, I ask him where rates are going. His answer? Yellen has given us plenty of guidance and we should listen. "Within the next year, interest rates will start to go up slowly. And, you know, maybe after another decade or two, there will be some trust that, when they say interest rates will bekept low for a period of years, people will think that maybe that will really happen."

I'm not so sure. I don't think central bankers have any more idea of what will happen over the next decade than we do. That makes their long-term guidance pretty useless. Still, we leave it there.If you want to hear more from him(I always do and you should too!), you'll need to buy Misbehaving.

Who is Richard Thaler?

Richard Thaler, 70, is a behavioural finance theorist widely viewed as the father of behavioural economics. Originally from New Jersey, Thaler gained a PhD from the University of Rochester in 1974 and has taught at several American universities, including the University of Chicago, Booth School, where he is Professor of Behavioural Science and Economics. He has written and edited several books, including Nudge (co-written with Cass Sunstein), which became a global bestseller in 2008, and has strongly influenced economic policy-making, both in America under Barack Obama and in the UK.

His most recent book, Misbehaving: The Making of Behavioural Economics, was released in May this year and examines the impact of human miscalculation on markets and how we can use these miscalculations to make better decisions in our lives, our businesses, and our governments. Thaler also co-founded Fuller & Thaler, an asset management company that uses behavioural economics to help investors generate returns.

Merryn Somerset Webb

Merryn Somerset Webb started her career in Tokyo at public broadcaster NHK before becoming a Japanese equity broker at what was then Warburgs. She went on to work at SBC and UBS without moving from her desk in Kamiyacho (it was the age of mergers).

After five years in Japan she returned to work in the UK at Paribas. This soon became BNP Paribas. Again, no desk move was required. On leaving the City, Merryn helped The Week magazine with its City pages before becoming the launch editor of MoneyWeek in 2000 and taking on columns first in the Sunday Times and then in 2009 in the Financial Times

Twenty years on, MoneyWeek is the best-selling financial magazine in the UK. Merryn was its Editor in Chief until 2022. She is now a senior columnist at Bloomberg and host of the Merryn Talks Money podcast -  but still writes for Moneyweek monthly. 

Merryn is also is a non executive director of two investment trusts – BlackRock Throgmorton, and the Murray Income Investment Trust.