Why the internet accentuates investors’ biases

Posted by Robin Powell on October 1, 2019

Why the internet accentuates investors’ biases

 

As someone who spends a good deal of time keeping abreast of the latest academic research on investing, I’m constantly surprised at how much of it there is. There are very few aspects to this subject that haven’t been exposed to rigorous academic research.

What does surprise me, though, is how little research there is on the impact of social media on investment decisions. After all, behavioural finance is now a popular academic discipline, and the growth of social media is, let’s face it, one of the biggest social phenomena of the modern era.

Now, at least, we do have a helpful summary of the research that has been done in this area, in the form of a paper by April Rudin for The Investments & Wealth Institute, entitled Understanding How Social Media Affects Investor Biases. True, the data April cites comes not from academia but from social media firms and financial consultants, but it is at least a start.

 

Ordinary investors and professionals

There is evidence of a strong link between social media and the way that investors behave. Research by LinkedIn found that a quarter of high-net-worth individuals in the United States turn to social networks for financial purposes, including looking for information on which to base an investment decision.

But it’s not just ordinary investors who are affected. A study in 2015 by Greenwich Associates found that four out of five professional investors frequently use social media at work. Almost one third of the 250 asset owners interviewed said information gleaned from social networks had influenced their investment decisions.

 

Confirmation bias

The central thesis of April Rudin’s paper is that social media accentuates investors’ biases. This should come as little surprise to anyone who has followed UK or US politics on social media over the past three years. I’m sure there are examples somewhere of people who started off disliking Donald Trump but, as a result of social media, have ended up liking him; but there must be relatively few. The same applies to Brexit; spending time on social networks is only likely to make us even more entrenched in our existing views.

Confirmation bias is certainly rife on financial Twitter (often referred to by my Stateside colleagues as #FinTwit). I know from personal experience that trying to persuade a fellow social media user that they should look into the benefits of indexing when they’ve spent years advocating active management is a waste of time and energy.

I confess I have to hold my hand up on this one too. I tend to mute followers who repeatedly post unintelligent remarks; the rude and abusive ones I usually block, regardless of who they are.

 

Herd behaviour

Herding, April Rudin explains, is another bias that social media tends to exacerbate. Humans are very social animals. The thought that anyone else is doing something that we aren’t doing ourselves makes us feel uncomfortable, especially if we think we’re missing out on a financial reward.

As April says, that’s why people who know what they’re doing will post things like, “Three investment trends you’re missing out on”, or “Making this millionaire’s secret work for you”. It can be hard to resist clicking on a link like that.

Of course, the problem with joining the stampede is that you could be investing when it’s too late to benefit from the potential rewards. Also, it might be perfectly OK for one investor to follow a particular trend, but just the wrong thing for you to do.

 

Overconfidence

Finally, the article touches briefly on overconfidence. Again, it seems only natural that social media should make us more confident about pursuing a particular course. We might start off slightly unsure about investing in a particular fund or sector, for example, but watching lots of other people, seemingly just like us, doing precisely that can make us feel emboldened.

 

Conclusion

Arguably, then, most investors would probably achieve better outcomes by steering clear of social media altogether. But it’s clearly unrealistic to recommend complete abstention. Social media is part of modern life.

But, as an investor, you should use social media with your eyes wide open. Be aware of your own biases, and remember that every headline, blog or tweet conveys the bias of somebody else.

Finally, if you’re one of those investors who tend to be unnerved by scary headlines, you should definitely stay off social media when markets are in turmoil. It won’t make you feel any better, and it might just prompt you to do something you end up regretting.

 

April’s paper is a fascinating read and I commend it to you:

Understanding how social media affects investor biases

 

If you’re interested in learning more about the behavioural biases that can affect investors, here are a few more articles on the subject:

Active vs. passive investors: who behave better?

It’s only human to ignore the evidence in front of us

Active managers have biases too

 

Robin Powell

Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.

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