Liquidity…give them what they want

Behavioral finance is the study of how we make financial decisions. Finance professor Dr. Meir Statman spoke at a conference I attended last year and his basic argument is that we are all wired to act poorly as investors. Our fight or flight heritage gets in the way so we need rules and guidelines to overcome financially costly basic human tendencies. Meir generously shares his research and thoughts on his website and through his blog. – Santa Clara University – Leavey School of Business -Statman Profile

One of these rules or policy that I try to keep in mind is to be a liquidity provider. When the market is falling as it is this year, we should think about granting the emotional investor their wish. While the math may seem obvious it is a great mental check to categorize the liquidity preference of your strategy. Are you offering your position with the herd in flight or are you getting a preferred price by buying your position from those who want out…at whatever it takes. When stocks are rising the principle still holds. If a position is unbalanced and investors are fighting to get into what appears to be a can’t lose investment , give them what they wish for. Trading costs will be reduced since you will likely be selling at the offer or better and buying at the bid or better. In addition, your asset allocation decisions will be greatly advantaged by using this mental check.