Investors gamble as lottery playersStaff writer ▼ | February 26, 2009
Theories on how to play the stock market abound. Buy low, buy companies whose leadership you admire, invest in organizations that reflect your personal values. And don't count out the ever-popular strategy of throwing darts at the newspaper's financial pages. Every investor hopes he or she has figured out how to beat the system and turn a huge profit.
But what if your strategy isn't determined as much by analysis as by where you live? Or how old you are? Or if you bought a lottery ticket at the gas station yesterday? New research by Alok Kumar, assistant professor of finance at the McCombs School of Business, shows that geography, age and even whether or not you gamble, play a key role in how individual investors choose stocks.
Kumar and Federal Reserve Board economist George Korniotis studied the demographics and financial transactions of 70,000 anonymous investors and found a person's behavior in the stock market can be traced back directly to his or her personality and biography.
"In the past, economists viewed the market as one massive entity, driven by people motivated solely by the desire to maximize wealth," Kumar says. This relatively new field asserts that the market consists of thousands of individual players whose distinct backgrounds, beliefs, goals and fears influence their decisions—sometimes to the detriment of their wealth and the health of the market.
Evidence of counter-productive stock market behavior is outlined in Kumar's study, "Who Gambles in the Stock Market?". He found that the socioeconomic characteristics of people who play state lotteries are very similar to investors who pick stocks that have a lottery quality—high risk with a potential for high return. But just like playing the lottery, gambling in the stock market usually does not pay off. "We found that people who took risks in the stock market typically earned 2 to 3 percent less than other investors," Kumar says.
"The bottom line is that how our society behaves ultimately affects financial markets and perhaps even the broader economy," Kumar says. "In other words, what happens on Main Street has the potential to affect what happens on Wall Street." Ten years ago, this was a fairly radical notion, says Kumar. But that reality is becoming harder to ignore. ■