Narratives drive behaviour in all areas of life, and investing is no exception. In this video, Warwick Business School’s Professor RICHARD TAFFLER talks about the profound effect that narratives of all kinds have on markets and investor behaviour.
TRANSCRIPT
Robin Powell: Human beings have always used narratives to help us make sense of a complex and uncertain world. The stories we tell each other can be very influential, especially when they stir our emotions. A 2023 study, for example, showed how narratives make investors act irrationally during a market crisis.
Richard Taffler: What we find is that we can, in a way, distill down all these narratives into coherent stories at any one point in time, which seem to be fairly dominant and influential. But the key thing about this is that they generate emotions. So it’s our emotional responses to these triggers that then direct the way in which we make our investment decisions.
RP: It’s not just stories we find scary that adversely affect our investment decisions. A powerful narrative in the late 1990s, for example, was the exciting potential for so-called dotcom stocks to profit from the internet boom.
RT: The market went up something like 1200% and then, overnight, collapsed back to pretty much where it was. So that’s an example of where these stories, which generated enormous emotions of excitement and mania, led to this dramatic market bubble. And then of course when, ultimately, reality imploded – the bubble just collapsed and now the narratives all generated panic, revulsion, blame, and guilt for getting involved in the first place.
RP: It’s inevitable, in a market crisis – like the one at the the start of the COVID pandemic, for example – that we want to understand what’s going on and what the likely consequences are. The problem is that the prevailing narratives in times such as these are often based on little more than speculation.
RT: In the middle of a market crisis, it is perhaps not the best thing to look in one’s panic at particular views of pundits – often self-described pundits – because that can often only make things worse. Coming back to the market collapse in the first two months of the COVID pandemic and then its immediate recovery: if one had panicked and sold, then one ultimately would have lost 30%. If one had stayed in the market, then one would have made probably between 50 and 100% from the point of the time when COVID was first recognised.
RP: The best course of action in a crash or correction is almost always inaction. But it can be very hard to sit on your hands when prices fall — even for a behavioural scientist.
RT: Like all my other colleagues in finance, we are only human and prey to all the same fallibilities when it comes to investing. I think what behavioural finance teaches you is that you’re not going to be able to do any better than anyone else, and it’s best to just invest and forget.
RP: Remember, acting in haste in volatile markets is a very bad idea. If you’re in any doubt, you should always to a financial adviser first.
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