William Bernstein: Investors Need To Choose Between Entertainment Or Higher Returns

Johnny HopkinsWilliam BernsteinLeave a Comment

In his book – The Investor’s Manifesto, William Bernstein discusses why investors chase entertainment and excitement at the cost of higher returns. Here’s an excerpt from the book:

Not only do humans like to tell stories, they want to be amused by them. Owning shares of Netflix is much more enjoyable than owning, say, Consolidated Edison or Federal Screw Works.

Many, if not most, of our purchases of both consumer goods and investment vehicles can be broken into two parts: entertainment and investing. Consider a lottery ticket: Your one dollar purchase at the local convenience store is in reality a marketable security with a one-week expected return of about minus 50 percent. Clearly, a miserable asset class if ever there was one.

Yet, folks buy these things. Why? Because a lottery ticket’s return is only partly financial. What it lacks in strictly fiscal terms, it makes up for in entertainment value.

In other words, the heady but short-lived fun of dreaming about spending the rest of your life in Maui is the happy job of your greed center, the nuclei accumbens; this happy diversion supplements the low return. Taking this line of reasoning to its logical extreme, a theater ticket is an investment that compensates for its minus 100 percent return with a very high entertainment value.

As already alluded to, some investments entertain more than others. Initial public offerings (IPOs) of the stock of exciting new companies come most readily to mind.

A wealth of research demonstrates that IPOs have, in general, lousy returns with very high risk. This is not a new observation; threequarters of a century ago, investment legend Ben Graham, in his seminal Security Analysis, wondered why folks bought IPOs.

Here is why: It is so much more fun taking a chance on finding the next Amazon.com or Microsoft than owning a doggy industrial company. In short, IPOs are the investment equivalent of a lottery ticket, with high entertainment value and low investment returns.

A few decades ago, I enjoyed a dinner at a local franchise of a well-known chain of Asian restaurants. Impressed with the food and service, I researched the stock and saw that it was trading at a ludicrously expensive price relative to its earnings.

Clearly, because the business had such high visibility, and because ethnic restaurant chains were a hot item in the equity markets in those days, millions of other investors had already gotten the same idea.

Tens of thousands of happy diners bid up the stock’s price to the point that it was likely to (and eventually did) produce low returns going forward.

If you want excitement in your life, it is far safer and cheaper to take up skydiving than to seek it in your investment portfolio.

Thus, the more public visibility a company has, and the more well-known and entertaining its story, the lower its future returns are likely to be. By contrast, it is the most obscure companies in the most unglamorous businesses that often have the highest returns.

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