Feelings and Investment Decisions (Click to Enlarge)
Traditionally, being rational and objective was highly prized in the investment decision process. Emotions were to be controlled and repressed for fear of making bad decisions. However, early studies that combine psychology, the biology of the brain, and investment risk are beginning to challenge that view.
I recently read an article in CFA Institute’s magazine called “Sentimental Journey” that reviewed recent research. Cynthia Harrington referred to research conducted by Columbia Business School professor Michel Pham and associates published in the Journal of Consumer Research. They researched how people’s trust in their own feelings affected decision-making. The exhibit below gives a quick summary of the research.
Why It Is Important to Know How Trust in Feelings Affects Decisions
The researches are trying to figure out if gut instincts improve the accuracy of predictions in decisions in uncertain events with high stakes. This could help decisions made by professionals in many varied areas such as the Pentagon, Wall Street, weather prediction, to name a few.
Methods
Summary of “The Emotional Oracle Effect” (Click to Enlarge)
People were divided into two groups:
- People who had high trust in their feelings
- People who had low trust in their feelings
Subjects were asked to make decisions in the eight studies mentioned in the Exhibit to the right. (Click to Enlarge.)
Conclusions on Whether Feelings Help us Make Better Decisions
People who had high trust in their feelings were more accurate in their predictions in all the studies.
However, this effect only occurs when people have sufficient background knowledge in the decision area.
People who trusted their feelings didn’t make rash decisions. They still took the time to carefully consider the information.
Why Feelings Can Help Us Make Better Decisions
While a more analytical approach with just a few inputs might seem more logical, it could be leaving out key information that your feelings are hinting at. Study authors speculate that when a person trusts their feelings about a subject they have experience with, they access “a vast amount of information that people learn consciously and unconsciously about their environment.” Professor Pham believes that feelings “…tap into all we know about our environment.”
Knowing how and when to trust our feelings when we are choosing an investment can help us improve our choices.
Sources
“Sentimental Journey” by Cynthia Harrington. CFA Magazine, March/April 2013.
“Feeling the Future: The Emotional Oracle Effect” by Michel Tuan Pham, Leonard Lee, Andrew T. Stephen
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