Why Don’t Investors Stay True to Their Principles? Think Self-Deception

It can be remarkably difficult for investors—and advisors—to stay true to their stated investment principles over time. Whether an investor focuses on momentum investing, minimizing fees or using a valuation-driven approach, there are many pressures to stray—from the urge to chase returns, to getting caught up in fads, to running scared when the markets turn rough.  But why don’t investors resist those temptations?  Why don’t investors stick to their guns? One of the most troubling reasons is simply self-deception:  investors (and their advisors) just don’t realize that they breaking their own rules.

Here’s a personal and, frankly, embarrassing example. I recently moved to Chicago to be at Morningstar’s home office. Due to the particular timing of the move, I needed to liquidate some investments last year, and have been sitting on cash ever since the purchase. While I’m a valuation-driven investor who researches common investor mistakes...I’ve basically been trying to time the market. I’ve been avoiding my advisor and dragging my feet about reinvesting the money.  It’s a really, really stupid thing to do.

But I only realized that I was doing market timing-through-inertia when I started to prepare a presentation on this topic last week. I’d nicely deceived myself that it was okay to bend the rules a bit and wait for the market to fall further before reinvesting. And the markets have shot back up, of course.

How could this happen—in my case, or with the investors you work with?  A few years ago, behavioral economist Dan Ariely published a fascinating book that summarizes recent research into self-deception.  Here’s what the research says.

The Fudge Factor

When an investor, or anyone, commits to a virtuous course of action there’s usually a temptation to cheat, too.  For example, for a die-hard value investor, there’s a temptation to pick up a few overvalued but hot stocks, “just in case.”  When markets are bumpy, the temptation to break from one’s strategy is particularly intense.

When people are faced with conflicting incentives like this, they try to follow both sets of incentives at the same time. They balance their self-image as an honest person (following their stated course of action) with the temptation to cheat (chasing returns) by fudging things a bit.  

The degree to which they can rationalize the bad behavior determines how much they cheat—which Ariely calls the “fudge factor” (Ariely 2013—see footnotes below for all citations).

But there’s a limit to how far we can fudge—how far we can cheat and still maintain our image of an honest, virtuous person. Nina Mazar, On Amir and Dan Ariely (2008) ran a series of experiments to determine how much we cheat under a variety of scenarios. 

They started by asking people to complete some basic math problems and compared two randomly selected groups: those who self-reported how many they got right versus those who were independently rated.  The former group cheated, in experiment after experiment, by a whopping 50% or more; that’s right, they over-reported their number of correct answers by an average of 50%.

If that isn’t bad enough, there are three particularly terrifying things about their research:

  1. It wasn’t a few bad apples driving these results. The researchers found that many people cheat when given the chance by just enough to still feel like an honest person.
  2. People had no idea they were doing it. When forecasting future scores on a non-cheating version of the test, they deceived themselves about their abilities.
  3. Many situations can make the fudge factor far, far worse. For example, being tired or hungry increases cheating (Mead et al. 2009).  So does ambiguity about one’s exact commitments (Schweitzer 2006), lack of supervision (Ariely 2013), working in groups, seeing others cheat and being a particularly creative or intelligent person (Gino and Ariely 2012).

Stop the Fudge (Factor)

As an advisor, what can you do to help your clients stick to their guns?

Thankfully the same research on self-deception also gives potential solutions—it isn’t specific to investors, but can give us great ideas for the investment realm.  

One of the most powerful techniques researchers have found is reminders—reminders of one’s commitment to a path, which occur before the person tries to bend the rules. In the advising world, a quick review at the start of a client meeting, an email or call could all do the trick.  

Other techniques you can use are:

1) Remove ambiguity. If an investor says “I want to minimize investment fees,” ask them: “Excellent, how shall we measure that?” Make sure the investment strategy is carefully measured and the data is regularly seen by the client.

2) De-normalize. If a client is getting cues from other investors who are doing foolish things (chasing returns, etc.), don’t argue. Instead, point out the other investors who are following the strategies and reaping the profits accordingly, i.e., show it’s normal to stick with the plan.  For valuation-driven investors, that may mean invoking Warren Buffett. 

3) Take a pause. Because the temptation to break the rules is dependent on being hungry or tired, ask the investor to simply talk about it tomorrow—perhaps first thing in the morning.    

Over the coming months on this blog, we’ll talk about other ways you can help investors stay the course and limiting the room for self-deception is a great place to start.  And yes, I’m setting up a meeting with my advisor to get back in the markets now.

Research Referenced in This Article

Ariely, Dan. The Honest Truth About Dishonesty: How We Lie to Everyone--Especially Ourselves. New York: Harper Perennial, 2013.

Gino, Francesca, and Dan Ariely. “The Dark Side of Creativity: Original Thinkers Can Be More Dishonest.” Journal of Personality and Social Psychology 102, no. 3 (2012): 445–59.

Mazar, Nina, On Amir, and Dan Ariely. "The dishonesty of honest people: A theory of self-concept maintenance." Journal of marketing research 45, no. 6 (2008): 633-644.

Mead, Nicole L., Roy F. Baumeister, Francesca Gino, Maurice E. Schweitzer, and Dan Ariely. “Too Tired to Tell the Truth: Self-Control Resource Depletion and Dishonesty.” Journal of Experimental Social Psychology 45, no. 3 (May 2009): 594–97.

Schweitzer, Maurice E., and Christopher K. Hsee. “Stretching the Truth: Elastic Justification and Motivated Communication of Uncertain Information.” SSRN Scholarly Paper. Rochester, NY: Social Science Research Network, October 11, 2006.

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