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When Do You Ignore Your Gut?

October 5, 2012

If you’ve been underwhelmed by your so-called “safe” but low yielding investments over the past couple of years, you’re not alone.
-Franklin Templeton Investments


Anyone who took an introductory psychology class probably remembers the classic study in which different people witnessing the same crime each report a different take on what happened. Though each presumably sane, sober person witnessed the events with his or her own two eyes, individual expectations and biases influenced how they perceived what happened.  Sure, you say, but what does this have to do with investing?  Well, it turns out that our individual expectations and biases influence how we view investments, too.

  • Our thinking is often strongly influenced by what is personally most relevant, recent or dramatic.
  • Fear may be driving  investor decisions more right now than reality.
  • As the yield environment has shifted, many investors are faced with a choice of either changing their goals or changing their approach.

If you’ve been underwhelmed by your so-called “safe” but low yielding investments over the past couple of years, you’re not alone. The low-rate, slow-growth environment we’re in right now has investors facing a dilemma: relative safety feels comfortable, but it isn’t getting them much traction towards their goals. Meanwhile, riskier investments, which could offer greater potential to help them reach their growth goals, are just plain scary given the market tumult of the last few years.  While investment goals like retirement haven’t changed for most of us, suddenly the path to reach those goals has. What availability bias tells us is that investors’ lingering perceptions of a dire market environment may be causing them to view investment opportunities through an overly negative lens, making it less appealing to consider taking on investment risk, no matter how small the returns on perceived “safe” investments.

To shed further light on how our individual biases affect our decision-making processes, we had the opportunity to speak with Dan Ariely, James B. Duke Professor of Psychology and Behavioral Economics at Duke University and author of The New York Times bestseller, “Predictably Irrational: The Hidden Forces That Shape our Decisions.”  Much of Ariely’s work builds on the idea that we don’t really know our preferences as well as we think we do, or why we have them. In many cases, the environment—and other people—can sway us to a large degree. This applies to nearly every aspect of our lives. In the world of finance, he provides an example of how a financial advisor could create different biases, depending on how he or she might frame a discussion about risk.

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