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By ANDREW BLACKMAN

When it comes to investing, emotion is commonly seen as a weakness that must be shunned. But new research from professors David Tuckett and Richard Taffler suggests that emotions play an inevitable part in all investing, by amateurs and pros alike.

In their recent book “Fund Management: An Emotional Finance Perspective,” the professors present the results of interviews with 52 experienced fund managers in the U.S., U.K., France and Asia. The picture that emerges is one of acute anxiety and emotional conflict.

The bottom line, they say: Individuals and pros perform better when they acknowledge that investing is inherently emotionally charged and when they understand how emotions affect their behavior.

We talked with Prof. Taffler, professor of finance and accounting at Warwick Business School in the U.K., and Prof. Tuckett, a fellow of the Institute of Psychoanalysis in London and visiting professor at University College London, about the role of emotions in investing. Here are edited excerpts of those conversations.

Relationships With Stocks

WSJ: What do you mean by emotional finance?

PROF. TUCKETT: What we try to do in emotional finance is start with the fact that the future is unknowable. The key thing about uncertainty is that it inevitably generates feelings. Because it matters to you, because your money’s on the line, so to speak, you’re bound to feel emotionally engaged.

WSJ: Some people think pros are more rational than individual investors.

PROF. TAFFLER: Although most of the fund managers we interviewed saw part of their particular competitive advantage as remaining, as they described it, unemotional or rational, in practice they were just as emotional as anyone else when they started to talk about the stocks they had invested in. There were lots of examples where they referred to them almost as if they were lovers.

If you’re entering into an emotional relationship with a stock, an asset or a company that can let you down, this leads to anxiety, which is often not consciously acknowledged. But it’s there, bubbling beneath the surface.

Stories and Fantasies

WSJ: The fund managers told stories about their investments. What was the role you found that storytelling played in their decision making?

PROF. TUCKETT: They have to feel conviction. With a narrative you can join up different facts with emotions, and that creates a sense of conviction, and that is absolutely essential for action. So we aren’t saying “Oh, they’re only storytellers.” We’re saying you need to tell a story.

PROF. TAFFLER: One of the fund managers talked about investing in a fast-food company, how he visited the restaurants and looked at what people were ordering. The story was about seeing something nobody else could see, and that feeling gave him the confidence to invest.

WSJ: Could you talk about what investors expect from fund managers and what effect that has on the fund managers?

PROF. TAFFLER: A very important insight in emotional finance is the concept of the fantastic object. It’s like Aladdin’s lamp, which you polish and can have anything you want. In unconscious terms this is ultimately what we are all looking for.

The whole environment is problematic, because fund managers are expected to outperform on a continuous basis, in competition with other equally able and well-resourced managers, and of course not everyone can do this. So actually the fund managers are required to be fantastic objects, to earn continuous superior returns at low risk. This is, of course, only possible in fantasy, not reality.

To be able to do this, fund managers have to be able to believe they can find fantastic objects themselves, stocks with which they can have special relationships and which are going to outperform with minimal risk.

Wishing on a Star

WSJ: With individual investors, I suppose it’s about managing the uncertainty of putting their money into the markets—it helps if they’ve got this idea of the star manager who can handle it all for them.

PROF. TAFFLER: Yes. In emotional-finance terms an important part of the fund manager’s job is to defeat uncertainty. In a sense we’ve got an institutional structure which seeks to deny that ultimately we’re all working in an environment that is inherently unpredictable.

WSJ: What can individual investors learn from your research?

PROF. TAFFLER: I’ve done separate research on individual investors, and of course they have all these same feelings writ large. You need to recognize that cognition and emotion go together; you can’t have one without the other. If you were coldly unemotional, which is of course not possible, then you wouldn’t actually be able to generate the conviction necessary to take the risk of investing.

Mr. Blackman is a writer in London. Email him at reports@wsj.com.

A version of this article appeared May 6, 2013, on page R6 in the U.S. edition of The Wall Street Journal, with the headline: The Cold Truth About Emotional Investing.

About 5% of U.S. consumers may pay more for loans and other products because of errors on their credit reports, according to a new Federal Trade Commission study.

The agency said 26% of the 1,001 consumers in the study found an error in at least one of their credit reports from the three big credit-reporting firms—Experian, TransUnion and Equifax. (See the Ten Things column for more on the credit bureaus.)

The FTC said 13% saw a change in their credit scores after their credit reports were modified to address the errors. For about 5% of the participants, higher credit scores placed them in a lower tier of credit risk, making it more likely they’ll be offered loans at lower interest rates, the agency said.

The Consumer Data Industry Association, a trade group, said most errors were the result of inaccurate information lenders provided to the credit-reporting firms.

—Brent Kendall

Real Time Economics Blog

WSJ.com

Sales-Tax Swings

How does your locale compare with others when it comes to sales taxes?

Many states allow sales tax both at the state and local level, “so an area with a moderate statewide sales tax rate could actually have a very high combined state/local rate compared with other states,” says Tax Foundation economist Scott Drenkard.

According to a new report from the Tax Foundation, a research group, Tennessee (9.44%), Arizona (9.16%), Louisiana (8.87%), Washington (8.86%) and Oklahoma (8.67%) have the highest combined state and local sales taxes.

The five states with the lowest combined state/local rates greater than zero: Alaska, Hawaii, Maine, Virginia and Wyoming.

Five states have no statewide sales tax: Alaska, Delaware, Montana, New Hampshire and Oregon. But Alaska and Montana allow cities and towns to levy local sales taxes.

California has the highest statewide sales tax: 7.5%. Indiana, Mississippi, New Jersey, Rhode Island and Tennessee each have 7%.

—Laura Saunders

Total Return Blog

WSJ.com

Carrots and Sticks

Companies are increasingly encouraging workers to seek additional medical opinions before proceeding with expensive treatments—some with financial carrots and sticks.

Getting a second opinion before surgery might earn someone a lower deductible on their insurance; failing to get one could mean higher premiums or lower reimbursement.

While employers say they want their workers to make informed medical decisions, experts say the second opinions also often convince people to choose less invasive or cheaper treatments.

These second-opinion services, which are free to employees, ask independent specialists to remotely review medical case files and recommend a course of treatment. In most cases, employees never see the doctor at all.

—Jen Wieczner

MarketWatch.com

Minimum Wage

President Barack Obama has called for raising the federal minimum wage to $9 an hour, from the current $7.25, and linking additional increases to inflation. The proposal is likely to have a bigger impact on some states than others.

Nineteen states and Washington, D.C., have minimum wages higher than the federal rate. Only Washington state’s, at $9.19, is higher than the proposed $9. Oregon’s is $8.95. Arkansas, Georgia, Minnesota and Wyoming have rates lower than the federal minimum, but the federal standard applies in those states.

—Real Time Economics Blog

WSJ.com—The Aggregator, edited by Cristina Lourosa-Ricardo, features news and commentary from The Wall Street Journal and other publications. Email: cristina.lourosa@wsj.com

By ANGUS LOTEN

Stephen Voss for The Wall Street Journal

‘It’s just such a terrible feeling,’ says Kerry Koletar, shown at her family’s Baltimore flower shop, which might be left on the hook for unpaid taxes.

An estimated four in 10 business owners farm out management of their payrolls. But many, including Kerry Koletar of Baltimore, are coming face to face with a downside of that strategy.

The 44-year-old bookkeeper, whose family opened its flower shop five decades ago, figured the Internal Revenue Service had made a mistake when it informed her last year that the business owed $22,000 in unpaid employment taxes. She says she shrugged it off because the contractor that handled paychecks for the shop’s 13 employees had reliably collected and paid the shop’s taxes for more than a decade.

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But the tax notices kept coming, and in mid-March, the payroll firm, AccuPay of Bel Air, Md., filed for bankruptcy, saying it intended to liquidate. That same month, local police began investigating AccuPay for possible fraud, and have since handed the case over to the IRS, according to Detective Sgt. Jim Lockard of the Bel Air Police Department.

Ms. Koletar says she fears the shop, which had $750,000 in revenue last year, might be left on the hook for the unpaid taxes: “It’s just such a terrible feeling,” she says.

An IRS spokesman says federal law prohibits the agency from “discussing specific taxpayer cases or situations.”

James Vidmar, a lawyer for AccuPay, says “no charges have been made or filed” against the firm or its operators, referring to the allegations that it had failed to pay clients’ taxes. He says the bankruptcy process will determine if any payments are due to former clients: “It’s way too early to say how much those might be,” he adds.

AccuPay’s bankruptcy filing lists several dozen local businesses as creditors, including the flower shop, veterinarians, dentists and construction firms.

An April survey of 1,500 business owners by the National Small Business Association, a Washington-based trade group, found that roughly 40% of small firms use outside payroll services for tasks ranging from issuing employee paychecks to paying state and federal employee taxes. One in three of the firms pay more than $500 monthly for those services, and some pay more than $1,000 a month.

Many business owners, including Ms. Koletar, view third-party payroll management as necessary because they don’t have the time to keep up with all the changes in taxes and other laws, and because the requirements are “overwhelming for a business like ours,” she adds.

The industry is dominated by a handful of large companies, such as Automatic Data Processing Inc.,

Paychex Inc.

and Intuit Inc.,

but thousands of smaller payroll services have cropped up in recent years to meet growing demand.

Bankruptcies are relatively rare in the industry because larger firms typically buy the clients from a struggling rival. But bankruptcy isn’t the only risk.

In the past five years federal officials have prosecuted at least two dozen mostly small payroll firms that together allegedly pocketed more than $300 million in taxes from their clients, according to an IRS tally based on public records.

Last week, a 37-year-old woman on New York’s Long Island was sentenced to three years in federal prison for her role in a $20 million employment tax scam at a Hauppauge, N.Y., payroll firm, according to the Federal Bureau of Investigation. In January, the owner of a Boise, Idaho, payroll firm received a four-year sentence for skimming more than $950,000 from clients’ paychecks to pay off his personal credit-card debts, among other expenses, according to the IRS.

That same month a Greensboro, N.C., payroll-firm operator drew a 15-year sentence for tax fraud and other crimes after using $4 million in stolen tax payments to buy jewelry, the agency says, citing court documents.

Michael Alter, founder and president of SurePayroll, a Chicago-based payroll firm, says that since the recession at least two or three payroll firms a year have been convicted of tax scams. “It’s a really sad thing, and it gives our industry a bad name,” he says. As the industry grows, he adds, tougher licensing laws are needed to weed out bad actors.

Setting up a new payroll firm generally doesn’t require a special license. Moreover, certain types of payroll-service providers, including so-called professional employee organizations, aren’t required to report tax payments to their clients.

Nina Olson, the national tax advocate, whose job at the IRS is to protect taxpayers’ interests, has called for new laws that would require a third-party payroll service to post a bond for its clients that would cover any lost tax payments. She also has urged policy makers to force all payroll services to file a record of tax payments that is available for their clients to see.

“Although the payroll-tax industry has evolved in the more than 60 years that have passed since employment taxes were enacted, the law has not kept up with this evolution,” Ms. Olson said in her agency’s annual report to Congress in January.

Michael O’Toole, a senior director of government relations at the American Payroll Association, a San Antonio-based trade group, says small payroll firms couldn’t afford to post bonds for their clients.

Two weeks ago at a bankruptcy hearing at a federal courthouse in Baltimore, Beverly Carden, AccuPay’s former president, took the Fifth Amendment on the witness stand, refusing to testify about the company’s operations or its assets.

In the past year at least a half-dozen of her former clients have filed separate lawsuits against the firm in Hartford County Circuit Court, including a Bel Air veterinarian and a nearby brewing company. Those claims, alleging that AccuPay had been pilfering tax payments for several years, are on hold, following the firm’s bankruptcy filing in March.

Sen. Barbara Mikulski, a Maryland Democrat, has called on the IRS to suspend any penalties or interest owed by AccuPay’s clients, who under the tax code are liable for any unpaid taxes.

Lavinia Poist-Eades, 75, a business manager at Carpet Authority Inc. in Bel Air, which hasn’t sued the firm, says she didn’t suspect anything was amiss until late February, when she says AccuPay suddenly stopped answering her calls. The day the payroll firm shut its doors, she says, her son drove to its office and found an angry crowd outside.

Ms. Poist-Eades estimates that the 17-year-old carpet cleaning and restoration business has lost at least $30,000 in tax payments over the years. “It’s awful. We’ve been growing pretty well, and now we get hit by something like this?” she says. She says she was interviewed about the case by an IRS criminal investigator as recently as Tuesday.

“They were always so pleasant. These were nice people,” Mike Kasun, the owner of ClearTree LLC, said of AccuPay’s owners. He says his tree removal and trimming company had been using the service since 2004 and now owes more than $80,000 in unpaid taxes.

Still, Mr. Kasun says he has already signed on with a new payroll service. “With 15 employees, managing payroll is an ordeal. It’s nuts,” he adds. “I want to be in front of my customers, not in the backroom doing paperwork.”

A version of this article appeared April 25, 2013, on page B7 in the U.S. edition of The Wall Street Journal, with the headline: Tax Surprise: When Payroll Firms Implode.