New psychology research from Princeton University suggests that the sound of a company’s name can influence its success in the markets — specifically, that stocks of companies with simple, pronounceable names outperform market averages. In addition, stocks with pronounceable ticker symbols (e.g. KAR) tend to outperform the market as well. The magnitude of the effect is greatest shortly after a company makes its market debut; researchers hypothesize that early in a stock’s trading life, public information about its prospects are scant, which magnifies the effect of subtler behavioral decision making biases.

Alter and Oppenheimer did a second study looking at 89 real stocks that were traded on the New York exchange between 1990 and 2004. They asked 16 undergraduates to grade the fluency of the stock names on a sliding scale. Then they checked on the stocks’ performance.

As anticipated, the more complex a share’s name, the poorer it performed on the first day of trading. The effect appeared to wane as time went on; after 6 months, when more information about the stock was presumably available, the name alone couldn’t be used to predict a single stock’s performance.

But the overall impact on a portfolio of stocks was, in this case at least, substantial. Alter and Oppenheimer calculated how much a US$1,000 investment would have fared if it were invested in either the ten most fluent, or ten least fluent, shares. After just one day, the fluent portfolio was $118 ahead of the tongue-twisters; and after a year, it was US$333 up.

Read more: Simple sounds make for sound investments - Easily pronounced stocks do better on the market

via kottke

Individual decisions can be badly thought through, and yet be successful, or exceedingly well thought through, but be unsuccessful, because the recognized possibility of failure in fact occurs. But over time, more thoughtful decision-making will lead to better overall results, and more thoughtful decision-making can be encouraged by evaluating decisions on how well they were made rather than on outcome.

– Robert Rubin, Harvard Commencement Address, 2001

Excerpted from More Than You Know, by Michael Mauboussin.

The answer is “NO”, as many savvy consumers already know. Yet there are many other types of insurance increasingly being pushed on consumers that are just as bad a deal. In Tim Harford’s latest Undercover Economist column for Slate, he argues that consumers are increasingly insuring themselves against small risks, due to a combination of aggressive marketing of insurance products and deep-seated risk aversion.

There is plenty of overpriced insurance around, always bundled with some other product. A popular cell phone retailer will insure your $90 phone for $1.70 a week—nearly $90 a year. The fair price of the insurance is probably closer to $9 a year than $90. Economists are rarely tub-thumping consumer-rights activists. We tend to believe that people are smart enough to fend for themselves. But the commercial success of this kind of insurance is perplexing. The pricing is grotesquely inflated, but something more fundamental is also going on. A rational consumer should scarcely look at this kind of insurance, even at a fairer price.

Harford points us to a paper by Matthew Rubin and Richard Thaler which makes the claim that rational consumers should never buy insurance against small losses if it carries even a scant premium. A small loss is trivial in the context of our lifetime incomes, well north of $1,000,000 for many Americans. Yet this advice runs counter to the inflated psychological pain we often experience from even small losses.

Matthew Rabin and Richard Thaler pointed out in 2001, in a paper that surprised even their fellow economists, that anyone who pays even slightly more than the fair premium to escape from a risk on a $90 phone or a $900 insurance deductible must be making a mistake. The stakes are too tiny: In the context of a $1 million lifetime income, even $900 is a small enough risk to swallow. We should turn down these offers of insurance and save the money in a contingency fund to pay for the occasional loss. The odds would be well in our favor and the petty uncertainty shouldn’t cause us a single sleepless night.

But I know only two other people who actually behave like this, and both of them are wealthy economists. Why will the practice never catch on? Economic psychologists have determined that we find it impossible to put our losses into context. I should recognize that the value of my home fluctuates every hour by more than the value of the cell phone I put through the washing machine—but it will be the loss of the phone that upsets me, and it is the risk of that upset that the phone insurers will try to emphasize.

The correct response is to insure yourself only against the big risks, such as your house burning down. As for the dent in the rental car, you will simply have to tell yourself that in the scheme of things, it’s not that important. That is the closest that economics will ever come to Taoism.

Micromotives favorite Michael Mauboussin has a new book which is about to be released on Columbia University Press! It’s called More Than You Know: Finding Financial Wisdom in Unconventional Places.

Michael J. Mauboussin is known throughout the financial world for his innovative approach to succeeding on Wall Street. His unconventional methods have earned him a place on Smart Money’s list of the “Most Influential People on Wall Street” and in the Wall Street Journal’s All-Star survey. In More Than You Know, Mauboussin shares his secret to becoming an insightful investor and provides invaluable tools to better understand the concepts of choice and risk.

Mauboussin develops sound investment strategies by drawing on diverse sources and disciplines. He builds on the ideas of sage yet diverse visionaries including Warren Buffett and E. O. Wilson, but he also finds wisdom in a range of activities and fields that is both broad and deep, including: casino gambling, horse racing, psychology, and evolutionary biology. He analyzes the strategies of poker experts David Sklansky and Puggy Pearson and pinpoints parallels between mate selection in guppies and stock market booms. Ant colonies, Tupperware parties, “hot hands” in basketball, slime mold, and Tiger Woods’s swing all have something to tell us about smart investing.

More Than You Know is written with the professional investor in mind but extends far beyond the world of economics and finance. Mauboussin groups the essays into four categories: Investment Philosophy, Psychology of Investing, Innovation and Competitive Strategy, and Science and Complexity Theory . . .

Mauboussin’s strategy papers for Legg Mason have incorporated many fascinating and important ideas from the sciences into a comprehensive investing methodology. Can’t wait to see what this new book has in store!

Previously:

• Mauboussin on Discounted Cash Flow Models
• Mauboussin on Strategy: Size Matters
• All posts tagged Michael Mauboussin