We all know, and frequently acknowledge, that unthinking behaviour can lead to unpleasant consequences. Misunderstanding. Regret. Loss. These are just three of the results of unthinking behaviour. But what happens when unthinking behaviour influences investment decision-making?
Selective memory is another of the human biases that influence investment choices. According to Morningstar Inc., a global provider of independent investment research, it is behaviourally related to overconfidence – another investment bias we have discussed in the recent past.
Preserving our self-image
Few of us want to remember a painful event or experience in the past, particularly one that was of our own doing. In terms of investments, we certainly don’t want to remember those stock calls that we missed much less those that proved to be mistakes that ended in losses.
The more confident we are, the more such memories threaten our self-image. How can we be such good investors if we made those mistakes in the past? Instead of remembering the past accurately, we tend to remember it selectively. This response suits our psychological needs and helps preserve our self-image.
Incorporating information in this way is a form of correcting for cognitive dissonance, a well-known theory in psychology.
Cognitive dissonance posits that we are uncomfortable holding two seemingly disparate ideas, opinions, beliefs, attitudes or, in this case, behaviors, simultaneously. Our psyche, so the theory goes, will somehow need to correct for this.
Selectively adjusting memory
Correcting for a poor investment choice of the past, particularly if we see ourselves as skilled traders now, warrants selectively adjusting our memory of that poor investment choice: ‘Perhaps it really wasn’t such a bad decision selling that stock?’ Or, ‘Perhaps we didn’t lose as much money as we thought?’ Over time our memory of the event will likely not be accurate but will be well integrated into a whole picture of how we need to see ourselves.
Another type of selective memory is representativeness, which is a mental shortcut that causes us to give too much weight to recent evidence – such as short-term performance numbers – and too little weight to the evidence from the more distant past.
Quite apart from being inherently fascinating as subjects for discussion, behavioral pathologies – it’s accurate to refer to them as quasi-psychological conditions – can be deeply self-destructive. A very important part of our job as wealth advisors is to prevent clients falling into behavioral traps of their own creation.
The Wooding Group, 780 498-5047