Marketing investment products is ultimately not that different from promoting breakfast cereals. A vast industry spends hundreds of millions of dollars each year getting their brand in front of people, in the hope that when they make a decision about investment they’ll go with the familiar. In doing so, fund companies rely on a behavioural finance quirk called “the availability heuristic” — otherwise known as the front-of-mind effect.
During the recent tech boom, there were fewer more searched for names in fund management than Cathie Wood. And for good reason. Her flagship ARKK Innovation exchange traded fund had risen fourfold from its March 2020 lows to February 2021.
Wood was perceived as having a golden touch, with her big bets on disruptive technology companies like Tesla and media streaming player Roku. Chances are if you wanted to go “long” tech, the ARKK fund would be a top-of-mind purchase.
Things have turned a little sour since that year-ago peak, however. The ARKK price has fallen by more than half, and outflows have accelerated, as rising bond yields hammer the high-priced growth stocks on which Wood made her biggest bets.
While Wood still has plenty of believers, the view that held early in the pandemic — that the path to riches was to keep buying up tech stocks seen as likely to benefit from the new stay-at-home economy — is not as firmly held as it once was.
It’s a timely lesson on the dangers of the “availability heuristic”, sometimes known as the front-of-mind effect — a mental short-cut identified in behavioural science in which people make judgements about a person, product or trend based on its visibility and how easily it comes to mind.
The origins of the theory
Like so many of the ideas in behavioural science, the front-of-mind effect comes out of the pioneering work done by psychologists Daniel Kahneman and Amos Tversky in the 1960s and 1970s. Their work on human judgement under uncertainty focused on a number of behavioural biases, the availability heuristic among them.
So how does it work? Let’s say you are planning a family holiday abroad and there is an item on the TV news that night about an airline crash in which no one survived. You might decide to switch your plans to a motoring holiday at home, even though the statistics show you are far more likely to be killed in a car crash than a plane crash.
You also see this tendency after natural disasters. The number of people seeking to insure themselves against that sort of disaster – an earthquake for instance — tends to rise dramatically, even though a repeat is seen as highly unlikely.
In short, we often make judgements with incomplete or partial information or based on what just happened. To put it bluntly, we are not as rational as we think we are and can be easily swayed by news or information that is more recent, visible or accessible
Of course, this is precisely why financial services firms spend a fortune on advertising. To give you an example, AC Nielsen data shows 11 asset managers in the UK spent more than £100,000 on advertising during the second quarter of 2020 as people reassessed their finances during the first Covid lockdown.
And even without traditional advertising, Neil Woodford’s ill-fated Woodford Investment Management managed to build significant profile through social media and at one point was behind only Fidelity and Vanguard in UK social media presence.
The reason for such intensive marketing is that fund managers know that people will often choose investments based on how frequently they appear in the news, social media or billboard advertising. Disciplined research or due diligence involves far too much work for most of a time-poor population.
Unfortunately, the result of these mental shortcuts is many people end up with portfolios that are overly concentrated, excessively risky, expensive and opaque. The familiarity of a brand name will often trump all other considerations and once they have made the decision they tend to look for information that confirms their biases.
Countering the front-of-mind effect
It is hard, if not impossible, for us to discern availability bias in our own behaviour, which is why having a financial planner as a sounding board can be a valuable investment.
If we have a tendency to overweight recent and newsworthy events and people, it is good to have another source as a devil’s advocate.
In the case of Cathie Wood, for instance, an adviser might say: “Well, she has had a good run, but does that necessarily mean she will keep on winning? Do you really want to make such a big bet on a single sector? And keep in mind if you are paying these high prices, that means your expected return is correspondingly lower.”
We can also help ourselves by reading more widely, and more critically, examining our motivations and committing to not making a decision on impulse or purely based on the heat associated with one product or individual.
At the end of the day, it is good to remember that just because an option comes readily to mind doesn’t necessarily mean it is the right one.
ALSO IN THIS SERIES
If you’re new to investing, TEBI founder Robin Powell and fellow financial blogger Ben Carlson have written a book that you really ought to read. It’s called Invest Your Way to Financial Freedom, and it’s published by Harriman House.
Primarily written for a UK audience, the book has no hidden sales agenda and is based on peer-reviewed academic evidence. It explains, in simple terms, how young investors can develop good habits, save a fortune in unnecessary fees, and achieve financial freedom many years earlier than they otherwise would.
You can either buy the book direct from the publisher or via Amazon:
For those in the UK,
For those outside the UK,
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