With their historically risky and controversial decision-making, Wall Street and investors are often called selfish, greedy and perhaps evil. John Nofsinger of Washington State University suggested that universal human biases and emotions are responsible for many poor investment decisions. The Finance Professor made his case in his “It’s Not Just Fear and Greed” presentation last Friday at the College of Business.
Nofsinger cited psychological findings in his presentation that helped explain poor decision-making by investors. These findings are forms of bias and emotions that Nofsinger emphasized throughout the presentation that all people suffer from, not just investors.
“Just because we know about bias doesn’t mean we don’t suffer from it,” said Nofsinger when explaining how powerful bias is over the individual.
Nofsinger said the Representativeness Bias where investors tend to invest in stocks with favorable numbers in the past and present even though unfavorable numbers are possible in the future.
Another bias explained by Nofsinger was the Familiarity Bias, which he compared to the local football fan’s tendency to rank their local team higher than they deserve. Likewise, investors buy stocks in a company familiar to them. To put in context Nofisinger said, “If an investor owns a Ford, they are more likely to invest in Ford.”
Nofsinger suggested that biases often lead to failure for investors and many people just cannot seem to overcome their bias. Nofsinger said, “We don’t learn very often from other peoples’ mistakes and that is very sad.”
Regarding emotional influences, Nofsinger discussed the influence of the human desire to win and the unbearable dislike for losing. In response to failed investing, Nofsinger explained the investor’s tendency to recover their losses at any cost.
“We hate losing money. If we have any chance to get back to even we are going to. Taking a loss can be twice as painful as the joy of gaining. Losing is harder on our psyche,” he said.
Measures could be taken to prevent bias and emotion from influencing investment decisions according to Nofsinger. Some of these measures include an investment plan to set realistic goals and sticking to quantitative analysis when making the big decisions.
However, Nofsinger conceded that fear and greed will always be present in investing. Nofsinger used the words of the world’s most successful investor Warren Buffet to explain that fear and greed are inevitable to play a role in investments, “You have to be fearful when others are greedy and you have to be greedy when others are fearful.”
