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June 30, 2008 at 08:00 PM
We receive quantities of financial information that would have been difficult to obtain in decades past; data that is amazing for its diversity and depth. A 20th-century consumer that might have based an investing decision on a newspaper article and a stockbroker’s recommendation can now get hundreds of pages of data and dozens of expert opinions concerning the merits of the investment. This should be a good thing. Classical financial theory assumes we take in all this information, filter out the irrelevant stuff, and then arrive at a reasoned unbiased decision. But that is not what happens.
A 2001 study traced the performance of investors that switched from phone-based trading to Internet-based systems. Their performance went from consistently beating the market by 3 percent, to 2 percent worse than the market when they used the Internet. We think we should be making better decisions when we get more data, but our brain has a tough time distinguishing between irrelevant noise and critical information. We create an illusion of knowledge that forces worse decisions.
Our mind plays tricks on us. If we see the same story 10 times we mentally give it more weight than the story deserves by remembering it as “10 people say” rather than “1 person says 10 times.” If we are approached to buy an investment from the firm of “Morgan Lynch Goldman” we react more positively than if the investment is offered by “Brand X Securities.” Since we remember hearing the names Morgan and Lynch and Goldman in a financial context these memories exert a positive influence. However, the choice is not based on facts or reason, but on the illusion we know more than we do. Marketers of all kinds use the illusion of knowledge by creating company and product names that sound like positive images from our past, and by attempting to bombard consumers with similar messages.
What can be done to protect ourselves from this illusion?
Don’t be a data junkie. Watching CNBC all day creates noise, not meaningful data. Cancel subscriptions to info-duplicating financial magazines or newsletters. Not all e-mails need to be read.
