In this week’s Money Bias Series, we review two similar dispositions investors face: narrative fallacy and representative bias. Although these two biases are quite similar, it’s still worth pointing out how each may individually impact your mindset.
The more we educate ourselves on these money biases, the more we realize how they bleed into other areas of our lives. However, we are here to focus on how these biases can interrupt your financial endeavors. If you obtain takeaways to apply in your personal life, more power to ya!
The narrative fallacy is our innate desire to add simple meaning and explanation to events, especially random ones. In particular, our love of storytelling can cloud the facts of an event, creating a narrative fallacy to take place. According to Psychology Today, “psychologists use the term attributions (or causes) for people’s explanations of the events in their lives.” Falsified attributions can cause misguidance in our decisions, especially when it comes to finance.
The story of a stock and the company it represents can lead investors away from the facts of the company as a whole. This is why investors may not want to invest in value stocks because they don’t have the best stories yet. However, they may instead invest in a company with a great story as well as a great (and maybe expensive) price tag.
For example, we’ve all heard about investors benefiting from their Tesla (TSLA) holding. Now pundits (and your coworkers) try to compare new stock issues as the next TSLA. “Think if you bought (insert hot new stock here) stock today…it’s going to be like purchasing TSLA back in 2010…” However, TSLA hasn’t always been ripping and roaring like it is today. In fact, it’s been quite volatile. The likelihood that an investor holds during times like that are minimal at best, PLUS the outcome of a stock ending up like TSLA is also few and far between...but, that doesn’t make for a good story, does it?
Narrative fallacy pops up when people say things like, “This is the new normal!…..You won’t ever see mortgage rates like this again!….Markets are only going to get worse if she gets elected!” If the attribution seems far too simple, it probably is.
This one is tricky because it goes against our grain. We have been sharing stories with one another since the dawn of time. To remove the story and emotional element from something takes a lot of work. Nothin’ we don’t think our readers are capable of!
Representative bias is when we use mental shortcuts to explain events or situations rather than engaging in an analytical process. These ‘mental shortcuts’ can also turn into stereotypes. As an investor, you may be tempted to utilize similar information to justify a prescribed pattern. As a human being, you may be tempted to utilize similar information (poor kids with behavioral problems) to make assumptions about their life (they must have bad parents).
Representative bias can lead to investors making quick decisions and avoiding the analytical and rational mindset needed to construct an adequate portfolio. As an investor, we may assign a single event to the growth of a company. For example, “DoorDash (DASH) is doing great because of the pandemic.”
Quickness isn’t always an advantage when it comes to effective decisions. Our brains prefer to be as efficient as possible (fight or flight). This is why it can be so difficult to train ourselves to slow down. By asking ourselves questions (see below), we inherently slow down.
Narrative fallacy and representative bias are very, very similar. We don’t expect you (or us) to be able to point out which one you are facing in any given moment. The point of this reading, along with all of our money bias blogs, is to educate you on what to look out for.
As I write this, I think about how earlier this week Dan and I were discussing if we should pull the trigger on a real estate purchase because rates are at all time lows once again (this was also our thinking in 2016). Buying a real estate property is a story people LOVE to tell. Plus, who doesn’t love a good Instagram photo of a couple in front of their newly purchased homestead? However, is buying a home because rates are low enough information to make a *good* buying decision? What mental shortcuts am I taking? What factors am I ignoring (here’s some: Dan and I love our flexible living situation, we hate unexpected costs that come with home ownership, we still don’t know long term where we want to plant our roots…) See! I told you that financial advisors fall into the perpetual biased mindsets!
Rational decision making can be the most valuable asset in your financial plan. If you want help in this endeavor, send us an email at firstname.lastname@example.org
Disclaimer: This article is for informational purposes only and is not a recommendation of Fyooz Financial Planning, Natalie Slagle CFP®, or Daniel Slagle CFP®. Past performance may not be indicative of future results and may have been impacted by events and economic conditions that will not prevail in the future. Therefore, it should not be assumed that future performance of any specific security, investment product or investment strategy referenced in the article, either directly or indirectly, will be profitable or equal to the corresponding indicated performance level(s). No portion of the article shall be construed as a solicitation to buy or sell any specific security or investment product or to engage in any particular investment or financial planning strategy. Any reference to a market index is included for illustrative purposes only, as it is not possible to directly invest in an index. Indices are unmanaged, hypothetical vehicles that serve as market indicators and do not account for the deduction of management fees or transaction costs generally associated with investable products, which otherwise have the effect of reducing the performance of an actual investment portfolio.