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Are Hidden Biases Costing You Money?

Surprising influences on your appetite for financial risk

By Andrea Hilbert

You probably think you know what influences you when deciding whether to invest your savings in a low-interest checking account or a speculative Internet start-up.

First, it’s a matter of personality. It’s commonly accepted that each of us has an innate appetite for risk—an internal “set point,” if you like, that determines our baseline willingness to take a chance.

Second, our approach to any risk is naturally shaped by prior experiences related to that risk, and the information we gleaned from them. Researchers have found that those who lived through the Great Depression, for example, are less likely to participate in the stock market.

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But recent studies suggest that when it comes to personal financial matters, our adventurousness may be affected by factors other than nature and learning. This research raises the specter of invisible, unconscious risk biases that can be triggered by events and circumstances irrelevant to the decision at hand.

By causing you to act less than rationally, could such biases be costing you money?

Traumatic experiences

The idiosyncratic nature of most traumatic life experiences (like accidents, divorces, and crimes) makes it difficult to draw conclusions about their impact on future conduct. So a team of researchers from Cornell University that was interested in the effect of psychological shocks on personal financial behavior recognized the unique opportunity presented by a data set produced by surveys conducted by the University of Illinois in 2000. It contained information about the household investments of a sample of 467 U.S. war veterans.

Sixty-three percent of the veterans who participated in the survey had experienced combat during their service. After controlling for other factors that are known to influence investment behavior (including age, health, and level of education, among others), the researchers found that the veterans who had experienced combat were over 17 percent less likely to hold “risky assets,” defined as stocks in publicly held corporations or mutual funds. An observational study like this can’t prove that the trauma of combat caused the aversion to risky assets, because it is possible that other factors—particularly variables associated with selection for combat service—may have played a role. However, when the analysis was limited to World War II veterans, the only major veteran group where combat assignment occurred on a random basis, combat experience still significantly decreased the probability that veterans would hold risky assets, between 14 percent and 16 percent.

Social exclusion

Experimenters at three Hong Kong universities were interested in the relationship between social isolation and financial risk taking behavior. In four experiments in a lab setting, they created feelings of social exclusion in subjects, and then asked them to choose between two “gambles,” which in some instances were hypothetical and in others held the promise of an actual cash payment. They found that when subjects felt ostracized, they were more likely to choose gambles that carried greater risk but promised a bigger payoff, rather than options that promised a more certain, but smaller, return.

Additional analyses appeared to rule out that this relationship was driven by negative mood, lowered self-esteem, or impaired risk perception. Instead, it seemed to be explained by a heightened sense of the importance of money for securing benefits in life. The researchers hypothesized that popularity and money are the two “currencies” that people can use to obtain what they want, and so when efforts to build social connections fail, people are likely to need and seek more money.

The researchers also took their investigation beyond the lab in a field survey, and found that participants who reported feeling chronically socially excluded also described riskier investment portfolios and more frequent betting on horse races and casino gambling.

A feminine touch

Even something as seemingly inconsequential as a subtle, comforting touch may influence financial decisions. In 2010, researchers conducted three lab experiments examining the effect of a light pat on the back of a subject’s shoulder by a female experimenter. They found that it was associated with a greater appetite for financial risk, as demonstrated by a preference for risky gambles over sure payoffs, both hypothetical and real. The same effect was not produced by a male experimenter’s touch, or by a female’s handshake.

The findings suggested that the subtle female touch affected subjects’ feelings of security, and that it was this (rather than the touch’s influence on simply positive or negative mood) that was correlated with participants taking greater financial risk.

The researchers hypothesized that the experimenter’s physical contact was reminiscent of a mother’s comforting touch during infancy, which has been linked to an infant’s tendency to engage in exploratory behavior.

How to guard against irrational risk biases?

Two of the three studies described here were conducted primarily in lab settings, and so it is not clear how applicable the results are to real world scenarios. And the relevance of the observations regarding combat veterans to broader populations and circumstances is uncertain. Nonetheless, a couple of strategies that always make good financial sense have the added benefit that they are likely to counteract or guard against irrelevant factors exerting an undue influence on your personal investment behavior.

First, the more financial information and education you have, the better equipped you are to make good investment decisions. In the study of war veterans, analyses that looked at the “risky” asset classes of stocks and mutual funds separately found that combat veterans avoided stocks to a much smaller extent than they avoided mutual funds. The experimenters suggested that this may be due to challenges for individual investors in understanding the costs and risks associated with mutual fund investments. In addition, the study’s results showed that both being a college graduate and having attended graduate school were correlated with an increase in risky asset holding. As Vicki Bogan, associate professor at Cornell University and one of the authors of the study, puts it: “The differential investment behavior between combat and non-combat veterans is very significant and large in magnitude, but it’s clear that education helps to mitigate these effects.”

Second, it is advisable to avoid making important financial decisions in times or physical situations where you could be unduly influenced by emotion. Consider delaying big investment choices if you are experiencing stress or upheaval, such as following a breakup or during times of conflict with friends or family. And endeavor to separate a financial decision from settings in which you may be subject to manipulation by another person with an interest in your investment, such as a product salesperson or a counterparty to a negotiation (like the founder of that Internet start-up).

In short, try to give yourself the best opportunity to weigh your options in a neutral space and an impassive manner, with all the relevant information at hand. This may help to mitigate the influence of any unconscious risk biases that affect you, reducing the chance that they will steer you away from the best investment decision, and thereby cost you money.

Andrea Hilbert is a former PT intern.

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