I'm guessing that some readers clicking through here may just be looking for five stock picks. If that's the case, they're just a bit lower, but I suggest you stick around with the rest of us for a moment.
Others may have gotten here wondering, "Does my portfolio really need saving?" In truth, it's likely that everyone's portfolio needs some sort of saving from a very devious threat: ourselves.
Humans are well adapted for a lot of things. Making financial decisions isn't one of them. And when we fail, our bank accounts can suffer.
For your consideration
A few years ago, behavioral economists Shlomo Benartzi and Richard Thaler penned a paper titled "Heuristics and Biases in Retirement Savings Behavior." Broadly, the paper studied how well workers were adapting to the system of defined contribution plans for retirement savings. I homed in on the section that covered how participants were choosing their investments.
The paper recounted a 1995 experiment by George Loewenstein and Daniel Read that looked at how kids chose candy on Halloween night. In the experiment, one group of trick-or-treaters approached two separate houses that each offered them a choice between a Three Musketeers and a Milky Way bar, while another group approached a single house that had two heaping baskets of both candy bars and a sign that read "choose whichever two candy bars you like."
Of the kids that approached the two separate houses, 52% took two of the same candy bar -- presumably their favorite. However, every single one of the kids that approached the one house with the two baskets of candy took one of each, effectively diversifying their candy choice simply because both choices were in front of them at the same time.
Far from it. While a Halloween-night experiment with kids may seem a little out there, the way that retirement participants choose their investments is frightfully similar. If there are two choices in front of them, many investors will split their money 50/50. With four choices, it's likely they'll put 25% into each. This strategy obviously isn't based on any premeditated ideal allocation between stocks and bonds or aggressive or conservative investment options.
Potentially even more concerning was a 2004 estimate from Olivia Mitchell and Stephen Utkus that 5 million Americans had 60% of their retirement savings invested in company stock. And as a point of reference, that was after the Enron bankruptcy.
As I noted at the beginning, our brains simply aren't adapted for these kinds of decisions. When we're confronted with them, it is easy to offload the decision-making process to simple heuristics (rules of thumb). This can lead to benign-sounding -- but dangerous --decisions like blindly splitting up retirement savings into quarters, simply because four investment options are offered.
But of course, if you're reading this, it's quite likely that you're not the run-of-the-mill 401(k) investor. You're proactively reading about investments, so you're obviously mindful of what you're doing with your money. You couldn't possibly fall victim to these or other cognitive blunders, right?
Not so fast.
I recently highlighted the "focusing illusion," which causes people to make broad assumptions about something based on a single attribute. For investors, this could come in the form of constant headlines about Apple's (Nasdaq: AAPL ) iPad -- sales for the tablet may be fantastic, but that alone doesn't mean that the stock is a great investment.
All of the chatter about Apple could similarly lead to a case of the "mere exposure effect," which leads people to like something more simply because they're familiar with it. These are just two of a laundry list of cognitive biases to which we can fall victim.
Is there any cure?
To be sure, I am not advocating avoiding companies simply because they're the basis of mass-media coverage. In fact, I've said on a number of occasions that blue-chip stocks are among the most attractive investments out there right now -- for reasons well outside of their headline popularity.
However, it's also possible to grab the reins and gallop away from the cacophony of Wall Street and the 24-hour news networks that can bias your thinking. That means digging up some stocks that don't make the headlines and aren't covered by a gaggle of Wall Street analysts.
While I think it's a little harder to find bargains among small caps right now, there are certainly still some that look like winners. Take these five, for instance.
Forward Price-to-Earnings Ratio
Return on Equity
|Tower Group (Nasdaq: TWGP )||8.2||12.6%||3.3%|
|National Presto Industries (NYSE: NPK )||10.8||20.8%||8.1%|
|BGC Partners (Nasdaq: BGCP )||10.5||17.5%||8.6%|
|Koppers Holdings (NYSE: KOP )||11.6||52.7%||2.4%|
|AZZ Inc (NYSE: AZZ )||15.5||15.3%||2.0%|
Source: Capital IQ, a Standard & Poor's company.
Now, it's certainly possible to still slip into biases with these stocks. The nice-looking numbers in the table above aren't enough to conclude that any one of these is a great investment -- that'd be a focusing illusion. As a pair of Motley Fool Hidden Gems picks, I may have included AZZ and National Presto because of some mere exposure effect. And a bloated ego could have subconsciously put a halo over Koppers because the company name is similar to my last name.
All of that aside, digging past headlines, hoopla, and Wall Street jibber-jabber can often help you find stocks that you should be investing in for all of the right reasons. And I think there are a lot of very valid reasons to take a closer look at all five in the table above.
Of course if you're looking for even more small, undiscovered small caps, you should also check out our free special report "Too Small to Fail: Two Small Caps the Government Won't Let Go Broke."