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The BID

How to reduce investment bias

Esta semana com Emily Haisley, chefe de finanças comportamentais da Análise Quantitativa e de Risco da BlackRock

Uma loja de produtos domésticos começou a vender uma panificadora. De modo pouco surpreendente, quando a panificadora foi lançada, as vendas foram lentas. Porém, mais tarde, uma versão luxo 50% mais cara foi lançada. De repente, a versão original começou a desaparecer das prateleiras.

Quando se trata de dinheiro, as irracionalidades, ou vieses, são mais impactantes do que o comportamento de compra. Os vieses também têm impacto nas decisões de investimento. Neste episódio de “The BID”, Emily Haisley, chefe de finanças comportamentais da Análise Quantitativa e de Risco, discute por que o fato de entender e lidar com nossos vieses pode nos ajudar a nos tornarmos investidores mais inteligentes.

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    Mary-Catherine Lader: Here’s a story for you. A well-known home goods store starting selling a bread machine. When the bread machine first came out, sales were, perhaps unsurprisingly, slow. But then they put a deluxe version out that was 50 percent more expensive. And suddenly, the original started flying off the shelves. When it was put next to the new version, it was a bargain.

    Here’s another story. Duke students slept outside for weeks to get basketball tickets. Some students got tickets and some didn’t. The students who didn’t get tickets said they’d be willing to pay up to $170 dollars for tickets. And those who did, said they wouldn’t accept any less than $2,400 for their tickets.

    So humans are irrational. We learned this from Dan Ariely, behavioral economist and frequent user of that word, “irrational.” But when it comes to money, we’re even more so. We’re biased, we compare prices and the value of things relative to what is sitting next to them, and other arbitrary markers. We perceive what we own as more valuable simply because it’s ours. And when we have a chance to get something for free, we’ll wait in line, even if it means waiting for hours just to get it.

    On this episode of The BID, we’ll continue our discussion of behavioral economics with Emily Haisley. Emily leads BlackRock’s behavioral finance initiatives, where she focuses on how she can help portfolio managers and investors make better decisions. I’m your host, Mary-Catherine Lader, we hope you enjoy.

    Emily, thank you so much for joining us today.

    Emily Haisley: It’s a pleasure to be here.

    Mary-Catherine Lader: So on our last episode, we spoke with behavioral economist Dan Ariely. You are a specialist in behavioral finance. Now Dan defined behavioral economics as the study of how and why humans behave irrationally for various reasons, as opposed to the perfectly rational model that economists have historically worked from. So what is the difference between behavioral economics and behavioral finance, which you’re focused on?

    Emily Haisley: Well, they’re highly related topics. They are both obsessed with this distinction between what the economically optimal thing is to do versus what people actually do when you empirically measure them. And it’s just really that behavioral economics is more broad. It looks across all areas of economic life: savings, spending, altruism, incentives, negotiation, cheating, all things economic, whereas behavioral finance really zeroes in on the behavior of investors and how their individual biases might aggregate at the market level. But I’d say both of them really use psychology to explain this difference between what is economically optimal and what people actually do and may use psychology to try to fix it, to try to bring them closer together.

    Mary-Catherine Lader: So how did your team come about?

    Emily Haisley: The team has been around for about two and a half years, and it came about because of the co-heads of Risk and Quantitative Analysis had this realization that risks don’t only come from markets. Risks can come from investor psychology, the people making the decisions. So psychology matters, and when they looked around at the diversity in RQA, they found that there were very few people that had training in psychology and so they thought, ah ha, this is a risk, we have to get some of that talent in. And the burgeoning field of behavioral finance just has paper after paper after paper saying why psychology is important for investment decisions.

    Mary-Catherine Lader: What does that mean in practice? What does that entail?

    Emily Haisley: So, what we’re doing is taking all these biases identified in the academic literature, and trying to find them in our BlackRock portfolio managers and fund managers. And the idea is that if we can measure and identify their biases, we’ve struck gold because where we see a bias, there is an opportunity to either have them take risk in a more efficient way or to potentially improve their performance. Now, the way that we find these biases is we look at various different types of data, so we might just look at their fund history of holdings and transactions and performance. We may ask them to give us some data, so we have a trade diary project where we have some fund managers record their rationale, the time that they trade, and then we can do really cool analyses using natural language processing to take that free text rationale, put it into trade categories that can be analyzed, and link it to trade level performance. And then we also look at how they interact in groups, so we observe teams and look at data related to the team dynamics. And then finally, we even look into investor physiology, so we look for biases not just related to the brain but also biases related to the functioning of the body.

    Mary-Catherine Lader: So those are so many interesting questions. Of all those lines of inquiry, what finding has surprised you the most?

    Emily Haisley: Gosh, so I have to say that this is going to sound boring I think, but it’s just the variation. The natural variation that you see from person to person as individuals. I come from an academic background, and you’re just used to looking at experimental group 1 versus experimental group 2, and looking at average behavior. And so now I’m looking at individuals, so you get to know individuals on a really personal level, about their strengths and their weaknesses, the motivations for their decisions, and it’s just that no two people are alike. A bias one person may struggle with is not an issue at all for another, and vice versa.

    Mary-Catherine Lader: So one of the projects you’re doing is at the physiological conditions, and how that impacts an investor’s behavior. What are you doing and what have you found so far?

    Emily Haisley: Yeah. Well, so far we’ve just ran very small pilots on this topic, but we are poised to scale right now. And what we do is we actually measure investor physiology using several pieces of wearable technology. So one is a ring. And this gives us investors’ sleep, stress levels, activity levels, on pretty much a daily basis. It takes really accurate measurements while they sleep. And we also use something that is worn on the upper-arm that gives us basically real time stress levels during the day as they’re making decisions at work. I should stress that this all completely voluntary. Just whoever wants to participate can, nobody is obligated to. And it’s also completely confidential, so everybody controls how their data is used and who sees it. And the goal is pretty simple, the idea is that we want to help employees succeed and if they take care of themselves, they’re going to perform better. We know that chronic stress drains performance, and moreover, chronic stress actually kills risk appetite, which is essential for investors to be able to take risks and be sensitive to opportunities in the market. As opposed to becoming insensitive to those opportunities, because their bodies are fatigued or stressed.

    Mary-Catherine Lader: So once you’ve uncovered a bias or a certain trait for an investor—it sounds like you work with both traders and investors, right?

    Emily Haisley: Mainly with fund managers, hedge fund managers, yeah.

    Mary-Catherine Lader: Okay. So once you uncover a bias that a fund manager might have, then do you work with them to alleviate it, to avoid it the next time?

    Emily Haisley: Absolutely, yeah. We’ll measure biases, we find one, and we can offer some help, some guidance. And then we show the evidence, they quite rightly kick the tires on it. We’ll then implement different interventions for overcoming the bias. And again, this depends on what exactly the bias is, it depends on if it’s coming from the individual or whether it’s coming from the team, so very personal in the recommendations we give.

    Mary-Catherine Lader: What other biases do you see in people who are managing portfolios and fund managers, and how do they come about? Are they earlier on in a career, do they get more pronounced after years of experience?

    Emily Haisley: I think that this is a really interesting question and one that deserves a lot more study. I don’t have an answer for every bias, but one really common bias is called the Disposition Bias. And this is related to loss aversion. Our brains are kind of wired to encode losses as twice as painful as an equivalent gain is pleasurable. And this is so hardwired, even monkeys show loss aversion when you let them use currencies and tokens that they can exchange for grapes and cucumbers, and let them gamble with coin flips and things like that. And what this leads to in investment decisions is sometimes if you buy a security and it doesn’t perform well, you may hold onto it for emotional reasons, rather than rational reasons. You may hold onto it because you don’t want to realize a loss, you don’t want to crystalize loss and feel that pain. So there is this tendency, particularly for retail investors, or everyday investors, or for more junior fund managers, to have the Disposition Bias, to not want to admit when they’re wrong, to not want to admit defeat. And then as investors get more and more experienced, they realize that in markets, you’re wrong all the time and if you’re slightly more right than you’re wrong, you can outperform. So they kind of get used to being wrong to accepting their mistakes, and they develop a discipline for cutting their losses. So the Disposition Bias tends to be one of the first ones that goes away.

    Mary-Catherine Lader: And do some biases come up at different times of day, different times of year? What kinds of context and external conditions can investors control?

    Emily Haisley: Yeah. There are all different biases related to calendar effects and related to weather effects, things related to the outcomes of sports games. When your country’s team loses, the investors become more pessimistic. Over the course of the day, because we’re looking at investor physiology, one of the findings that we notice is that people have these natural rhythms through the day of when they’re having greater readiness or greater levels of energy, and then they typically kind of hit a trough towards the middle of the day, and then might come back. And there are individual differences, some people are more morning people, some people are more evening people. But what we notice is that investors’ conviction throughout the day—so how much conviction they have in particular trade also follows this diurnal rhythm, this intraday variation in readiness. So they maybe have les conviction in a particular investment idea, simply because they’re picking up on an internal signal from their body that may be a bit fatigued rather than information about the fundamentals of the company.

    Mary-Catherine Lader: These all sound kind of personal in getting to know these subjects, if you will, pretty closely. Do you find that people you are working with get a little defensive or don’t really want you to know so much about them?

    Emily Haisley: Well, I don’t really so much think of them as subjects as more like almost like clients. Like they are people that I’m there to help and to support however I can. And the more data they give me, the better I can support them. But in answer to the question about defensiveness, I was shocked that they aren’t more defensive. I’m really surprised—pleasantly surprised by the culture here, the fund managers. They have what psychologists call a growth mindset, in that they don’t believe that skill or intelligence is fixed, it’s not something you are just born with and then that’s it. They have the belief that through hard work and persistence, and constantly evolving their investment process, they can get better and better over time. And so they see behavioral finance as a way to do that, as a way to get an edge.

    Mary-Catherine Lader: Have you all found that biases ever result in better decision-making?

    Emily Haisley: I think that typically biases are defined by people making decisions that are not optimal in some way. Normally that’s in some kind of economically rational way. So it may be that if you define the outcome of a decision as, “Are you maybe happier?” maybe then biases can help you. But you’re typically poorer as a result. For example, the decision to play the lottery. Many people think that is related to a bias of overweighting the small probability of a win. So lotteries are clearly not great investments, they have a highly negative expected value, but they may bring you some joy. Some excitement, some entertainment value. But I will say that biases, while they generally don’t result in economically better decisions, the whole nudge literature is based on this idea that you take biases that normally work against people and turn them around to work for people instead. Let me give you an example. In some research I did in academia, we tried to use lotteries which are normally seen as playing lotteries as a bias. And we used them to supercharge incentives for preventative healthcare in a company that was trying to promote better healthcare in its employees. So we ran an experiment where we compared giving a financial incentive for participation in preventative healthcare program as a lottery, or you could have the expected value of that lottery for sure. And we found that there was much better participation with the lottery incentive.

    Mary-Catherine Lader: You’ve also run a study where employers emailed employees about contributing to their 401(k) and just like tweaking little bits of language here and there, a couple words had an impact. So can you talk a bit about what you found there?

    Emily Haisley: This paper was called “Small cues change savings behavior.” And in this we found that by giving people either a high or low anchor as they were considering how much they should save for retirement, dramatically influenced how much they would save. So consider increasing your savings contribution, you could perhaps increase your contribution by 15 percent, a high number. Very few people actually did that, but it dragged up the amount that people were actually were willing to increase their savings contribution. And this was much higher than if you gave them a low anchor saying, consider increasing your savings contribution by say one percent. Then we actually dragged it down a little bit relative to control groups. And I think this really emphasizes for people who are trying to implement these nudge policies to really test their interventions, experimentally, scientifically, and make sure that they’re nudging people in the right direction.

    Mary-Catherine Lader: There are a bunch of nudges already incorporated in 401(k) plans; employer match, and automatic enrollment set up. So what are those plans doing right, and what could be improved?

    Emily Haisley: Well yeah, I think these plans have come a long way in terms of incorporating lessons from behavioral psychology. In terms of how they can improve it, I think that the use of technology could dramatically improve outcomes for people. And increasingly, they’re starting to use apps. So putting in the palm of someone’s hand the ability to really easily increase your savings contribution is really important. And particularly, if you’re going to deliver financial education seminars, everyone in the seminar might agree, yeah, I want to increase my savings contribution. But then when they leave, life gets in the way. And they may not have their log-in details and they may not exactly remember what it was they decided to invest in, et cetera, et cetera. So putting it right in the palm of their hands so they can take action immediately, I think the impact of that cannot be underestimated. And then moreover, you can incorporate all types of nudges into the app. So for example, you could give them high anchors, you could try to get them to do impulse saving. What is really successful is having people commit in advance to not save right now today, but to increase their contribution rate at the time of their next bonus or the time of their next pay raise pay raise.

    Mary-Catherine Lader: How does this apply to everyday investors, people who may trade stocks in their spare time, or who are planning for retirement, for example?

    Emily Haisley: I’d say there are a couple of biases that are really important. The first is loss aversion, which we touched on before. The thinking about losses in the near term that comes when you begin to invest can really put people off investing. They tend to overestimate the probability of the loss and intuit that if they have a loss, it’ll feel really bad. And this can stop them from investing for their future. Economists often puzzle at why stock market participation is so low, so this idea of loss aversion can help explain it. Another example for everyday investors is that sometimes things that feel really safe are actually really risky. The safety is just an illusion. For example, investing in stocks from your own country, the country you live in, can feel less risky than investing abroad. Or investing in companies that you’ve heard of, like high street companies or household names, just because you know a lot about the company can make it feel less risky than it actually is. And so investors may under-diversify globally, or under-diversified within their stock portfolio as a result.

    Mary-Catherine Lader: And does something about our personal backgrounds inform those sorts of behaviors? For example, if you came of age during a recession or financial crisis, how does that affect peoples’ loss aversion or other biases?

    Emily Haisley: Yeah, absolutely. This is called the Depression Baby Hypothesis. And it’s this idea that whatever slice of financial history you experience is going to shape your risk preferences, your anxieties about inflation, and affect your investment decisions. In a really clever application of this, there is a recent finding that Fed bankers who set monetary policy, their forecasts, the hawkish or dovishness of their speeches, and their voting record is predicted by their birth year. By how much inflation there was over their lifetime.

    Mary-Catherine Lader: And what’s the science on bubbles for example? So I’m just thinking of other behavioral trends that have a historic impact on markets. Is there any science around massive buying behaviors that are divorced from fundamental value for example, that create bubbles?

    Emily Haisley: I think there are a lot of things that contribute to bubbles. You can think about herding behavior and this fear of missing out, and people talk about irrational exuberance. One of the funnest studies that’s looked at this is in this new field called neuro-economics, where they actually put subjects in fMRI machines, so they can see their brains. And in one study, the experimenters used an experimental trading market, where they knew bubbles tended to form, and they thought, okay, what’s leading to this irrational exuberance in their brains? And they expected emotions might be involved, so they were focusing in on emotions centers of the brain, and sure enough, they found that as the bubble was forming, there was this excess activation in the reward pathway of the brain. And so the reward pathway was leading to the value of the securities and overshooting their fundamental value. And so you might conclude from this, that okay, we’ve got to take emotion out of investment decisions, emotions trip us up, but it’s not that simple. What the investigators also found is that there were some participants who sensed that the bubble was about to burst and got out before it burst. And they were like the best performing subjects in terms of the amount of money that they made in the experiment. And what led these subjects to get out before the burst was also an emotion. It was activation in emotional center of the brain related to pain, discomfort, even disgust. And if you think about disgust, that’s an emotion that makes you spit out something, reject it, and that is exactly what these participants did. They had this emotion of disgust as an early warning signal that gave them the intuition to get out before the bubble burst.

    Mary-Catherine Lader: So can you test investors for disgust but then give them the courage to act on contrarian views?

    Emily Haisley: If only I had an FMRI wand, yeah, you’d better believe I’d be using it. But alas, the technology is not there yet.

    Mary-Catherine Lader: This is so fascinating, we could keep talking for a long time. But I’m going to end with a rapid fire round. So, I’m going to ask you a couple questions and answer each of them in one sentence or less, ready?

    Emily Haisley: Ready.

    Mary-Catherine Lader: Okay. So you’ve consulted companies like Google, McKinsey, obviously BlackRock, banks, and even the U.S. Department of Health and Human Services, in your behavioral science research. What one project across all of those, not just in the realm of behavioral finance, has surprised you?

    Emily Haisley: Well, I’d say rather than one project, it’s been a commonality across all of them that psychological framing of a decision trumps economic incentives.

    Mary-Catherine Lader: What’s a behavior of your own that you’ve tried to change based on your expertise?

    Emily Haisley: Every single aspect of myself. So how much I eat, how much I exercise, how much I procrastinate. I’m constantly trying to nudge myself towards better behavior.

    Mary-Catherine Lader: So what do you do to stop procrastinating?

    Emily Haisley: So actually, Dan Ariely’s work really influenced me there, where he has a paper on the impact of deadlines. And how much better students do if they have intermittent deadlines rather than just one deadline at the end. So I carve out my tasks with intermittent deadlines, and then to avoid procrastination, I just plan enough time to work to meet the deadline with a bit of a safety factor.

    Mary-Catherine Lader: Interesting. What is the secret behind being a smarter investor?

    Emily Haisley: This is a self-serving answer, but know the common mistakes and know your biases.

    Mary-Catherine Lader: Best book recommendation on behavioral science?

    Emily Haisley: Far and away, Michael Lewis’s book, who is the author of The Big Short, The Undoing Project.

    Mary-Catherine Lader: Interesting. And then based on all of your expertise and study of this subject, does money buy happiness?

    Emily Haisley: So savings buys happiness. It’s not that more income is going to make you happy, it’s being able to live within your means and having enough of a saving and investment buffer that lasts a long time if your income were to stop coming in today gives you peace of mind.

    Mary-Catherine Lader: Fascinating, thank you so much for joining us today, Emily.

    Emily Haisley: Thank you very much, Mary-Catherine.