Do You Invest Based on Gut Feeling? The Dangers of Heuristics
Psych 🧠- 374/500
Hello Reader.
This year, I’m trying to get back into publishing more insightful content.
And a new video (after a long time) was just published on our Instagram. Take a look!
What is it?
This research paper examines whether investors are susceptible to cognitive biases – specifically anchoring, representativeness, and availability – when making stock purchase decisions.
It also investigates whether this susceptibility differs between individual and professional investors, and across demographic factors like education, experience, and income levels.
The study focuses on two developing economies – Malaysia and Pakistan – and uses a mixed-methods approach combining surveys and statistical analysis.
Major Findings:
Heuristics influence stock buying decisions: Investors in both Malaysia and Pakistan were found to be susceptible to three common heuristics:
Anchoring and Adjustment: Relying too heavily on an initial piece of information (the "anchor") when making estimates or predictions, even if that information is irrelevant or inaccurate. Examples include sticking to initial price targets or relying on past market trends.
Availability: Overestimating the probability of easily recalled events or information. Examples include buying stocks that are frequently mentioned in the news or influenced by vivid memories of past market crashes.
Similar influence across demographics: The impact of heuristics was generally consistent across income groups and between investors making decisions for themselves versus for clients.
Education and experience mitigate the effect: Investors with higher levels of education and more investing experience were found to be less susceptible to these biases. This suggests that learning and experience can help investors to make more rational decisions.
Satisfy your hunger for psychology with our book 🤓👇
Get The Psych Handbook that has 150+ biases & fallacies explained with emojis!
Or the Amazon Kindle copy from here. (40% off)
What do I need to know:
Heuristics are prevalent in emerging markets: The study demonstrates that cognitive biases are not limited to developed markets, but also influence investors in emerging economies like Malaysia and Pakistan.
These biases can lead to suboptimal decisions: Relying on mental shortcuts can lead investors to overpay for stocks, hold onto losing investments for too long, or miss out on profitable opportunities.
Education and experience matter: Investors with greater financial literacy and market experience are less likely to fall prey to these biases.
Source:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5032047