How Perception Affects Your Investing Reality

The big “news” this week in social media was that Twitter did away with their ‘favorite’ button and replaced it with a ‘like’ button. This also meant a shift from a star to a heart when you click this function. The Twitter faithful was less than enthusiastic about these changes as you can see from some of the headlines:

The button still serves the same exact function. Favorites have always been used by people as a bookmark, to say thank you, to tell someone you think their tweet is interesting or funny or to politely end a conversation. Yet people’s perception immediately changed when things went from ‘favorite’ to ‘like’ and star to heart. Sure it should mean the same thing, but people start thinking about the symbolism of these words and shapes and it changes how they view things.

This same thing can happen in the stock market, as words can have a huge impact on investor actions. Meir Statman noted many of the different ways that words can alter investor perceptions in his book, What Investors Really Want:

Some company names, such as Barnings Incorporated, convey more positive sentiment than other names, such as Aegeadux Incorporated, because they are easier to pronounce. People expect higher returns from stocks of companies whose names are easy to pronounce than from stocks of companies whose names are difficult to pronounce. Stocks of admired companies are like beautiful loan applicants with easy-to-pronounce names, basking in the glow of positive sentiment. Stocks of spurned companies are like unattractive loan applicants, wilting in the dark of negative sentiment. We embrace stocks of admired companies, expecting returns higher than risks, while we shun stocks of spurned companies, keeping our distance from returns lower than risks.

Statman and his research team looked at the list of most admired companies put out every year by Fortune Magazine from 1983-2006. They found that the returns of the most despised companies were 2.5% more per year than the returns for the stocks of the most admired companies. Interestingly enough, the opposite can be true with regards to stocks with ticker symbols that are clever and easy to remember. In fact, researchers found that stocks with gimmicky stock tickers (think LUV, HOG, MOO, GEEK) actually outperformed the market over a twenty year time frame.

I’m sure some of this has to do with the fact that we humans love a good story. The group of admired companies has a well-crafted narrative that makes it easier for investors to equate a good company with a good stock. And the companies that put in the effort to think about a good ticker symbol obviously take the time to consider their marketing approach. But I think it’s more than that. People also like familiarity. They like to feel comfortable and hate change or uncertainty.

In my book I tell of another study where psychologists asked students to eat fudge that was shaped like dog feces. The students knew that it was fudge. They weren’t being tricked or anything sinister like that. But it was still difficult for them to get over the way the fudge was presented to them. The students knew their negative feelings about the looks of the fudge weren’t rational and they even acknowledged that they were being irrational. For some reason they still had a difficult time eating the fudge because of the feelings brought about by how it was presented to them

This is important for investors to understand because the financial industry is very smart about how they portray things in their marketing materials. They know exactly which buttons to push to sway people’s opinions and decisions, whether you know it or not.

Source:
What Investors Really Want

Further Reading:
How Framing Affects Investment Decisions & Outcomes

Now here’s what I’ve been reading this week:

• How to say “no” when it matters most (FourHourWorkWeek)
• Why the story failed at Valeant & Theranos (Bloomberg View) and also see Their Language (Research Puzzle)
• The Trinity Portfolio (Meb Faber)
• You’re not indispensable (Adventures in Capitalism)
• Why it’s so hard to save (NPR)
• In defense of short sellers (TRB)
• Bob Lefsetz: “Distribution without talent is a complete failure.” (Lefsetz Letter)
• Read of the week: A dozen thoughts on dealing with risk in retirement (Aleph)
• Reminder: I’ll be meeting with potential clients in NYC in a couple weeks (AWOCS)

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My new book, A Wealth of Common Sense: Why Simplicity Trumps Complexity in Any Investment Plan, is out now.