Normal Investors, Then and Now

Abstract:     
The 1960 issue of the Financial Analysts Journal contains a pair of remarkable articles. In the first, Edward F. Renshaw and Paul J. Feldstein proposed the creation of what we know today as index funds. In the second, John B. Armstrong argued against index funds.

John B. Armstrong is a pen-name of John C. Bogle, the founder of Vanguard who introduced the first of many index mutual funds in 1976 and remains their foremost advocate. Bogle reflected on index funds and changed his mind. The 60th anniversary of the Financial Analysts Journal is an opportunity for all of us to reflect on past changes of mind and perhaps contemplate future ones.

The year 1960 was in the midst of an extraordinary time when academics and practitioners of finance were changing their minds, switching from a framework where investors are normal to one where investors are rational. Normal investors are affected by cognitive biases and emotions, while rational investors are not. Rational investors care only about the risk and expected return of their overall portfolios, while normal investors care about more than that.

The portrait of investors as rational is the first foundation block of standard finance. Other foundation blocks are mean-variance portfolio theory, Capital Asset Pricing Model (CAPM), and market efficiency. I describe normal investors as they were portrayed in the Financial Analysts Journal and other finance journals before standard finance was introduced and as they emerged more recently in behavioral finance.

Number of Pages in PDF File: 18

Keywords: Behavioral asset pricing theory, behavioral finance, market efficiency, rationality

JEL Classification: G11, G12

working papers series