Psyched Out: How Our Subconscious Can Affect Investment Decisions

Most people (myself included), go about their days doing the things they do and making the decisions make without being fully aware of the role our subconscious plays in determining our behavior. Despite this, decades of psychological research have, and continue to confirm that our subconscious mind is largely responsible for much of our behavior.

In this article, I’m going to talk about a very well-documented phenomenon within psychological research: post-decision dissonance. If you’ve ever had to make a difficult decision, you’ve probably experienced the effects of this psychological occurrence. I’ll break it down for you.

Everyone has a set of beliefs, values, and ideas. These can be things like where you want to live, your favorite restaurant, your religious beliefs, or which football team you think has the best defensive line. Because people have so many different kinds of beliefs, values, and ideas, it would be nearly impossible for someone to live their life without experiencing information or behaving in ways that conflict with how they think.

Cognitive dissonance is the feeling of stress and discomfort that occurs when we behave or come in contact with information that is contradictory to our beliefs, values, or ideas. An example of this would be if I decided to go on a diet, and then ate an entire large pizza two days later. The cognitive dissonance here would be the discomfort I felt as a result of valuing the diet, but behaving in a way that conflicted with that value (eating an entire pizza).

Another type of dissonance is post-decision dissonance, which is the discomfort felt after choosing between two or more items and not being sure if you chose the right one. One example of this would be if I chose an iPhone over a Samsung Galaxy S8 and then felt stressed out and unsure of whether I made the right decision. That feeling of stress is the post-decision dissonance, and it increases as the decision gets more important (for instance, choosing a car instead of choosing a phone).

Because cognitive and post-decision dissonance are uncomfortable and stressful, and because people want consistency between their ways of thinking and the realities of life, when people experience dissonance they usually try to reduce it. The act of reducing dissonance is where trouble can arise, and it is also where this conversation moves to the stock market.

Say you are choosing between purchasing stock for one of two similar companies (Dogs Inc. and CatCo); you think Dogs Inc. is slightly better and you choose them. In order to reduce the post-decision dissonance you felt after picking between two similar companies, it is likely that you justify your decision by convincing yourself that Dogs Inc. is better than CatCo. There are two main ways you can do this:

  1. Ignoring negative information about Dogs Inc. and positive information about CatCo.
  2. Selecting positive information about Dogs Inc. and negative information about CatCo.

Fast forward a few months and CatCo is doing significantly better than Dogs Inc. Because of the effects of post-decision dissonance, it might be very hard to admit that you made the wrong choice, and that right now, CatCo is the better option.

The act of reducing post-decision dissonance can strongly shape your perception of a company’s performance and worth, and the extent of this effect increases with the amount of money you invest. Because pricier purchases are more important, they create more dissonance, and the more dissonance they create, the more reducing necessary. This means that the more money you invest in a stock, the more you need to be aware of subconsciously selecting or ignoring information. Luckily, there are ways to do this.

In the case of investing, you should always consider what the best investment is right now, given all of the information you have. Learn from your mistakes, but try to avoid letting the emotions or regrets of past experiences color your current decisions. Additionally, just because you are currently holding a stock doesn’t mean it was the right pick. If new information comes to light, whether it’s positive or negative, don’t ignore it.

You’ll make the best decisions when you consider all the information available in as neutral a way as possible. But remember: staying neutral means recognizing and accounting for the powerful effects of your subconscious.

See you next week,

Zach

 

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