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Is such a story possible?
There's this story of a small city in the US, and its about events that happened 30 years ago. There was nothing spectacular about this small city - it was just one of the many that dotted the country. One day, the city woke up to front page news headlines in the local newspaper highlighting a gruesome murder. Three days later, a daring daylight robbery in what was considered a peaceful neighbourhood made front page news. Barely a week later, the newspaper's front page carried vivid photographs of a burgled house, with photographs of the houseowner's family in tears, having lost so many valuables. Over the next 3 months, the city's local newspaper reported in its front page, a series of crimes across the city, ranging from murders to rapes to burglaries to kidnappings. The citizens of this city were now restless : crime was everywhere, nobody felt safe. The citizens staged protests against the local authorities and the police for failing to stop crimes in the city. Prominent citizens began talking about migrating to safer cities to give their children a safer environment to grow up in. The first prominent family that moved was front-paged in the local newspaper, with an emotion-charged interview of the couple and their kids, on how sad they were to leave their beloved city, but how necessary it had now become, given the soaring crime levels and the haplessness of the local administration to do anything about it.
The police chief was replaced, but that did not placate an angry public, who turned up in large numbers in the next local elections to defeat the incumbent mayor and elect a new mayor who promised to make the city safe again. All this commotion attracted the big national dailies and magazines to cover these events and soon, the small city had a bunch of nationally prominent investigative journalists who descended there to run features on the metamorphosis of a peaceful city into a crime capital.
One of these investigative journalists did some independent research and then wrote an article which claimed that the escalating crime rates in the city were just a figment of fertile imaginations and that data proved that crime rates in the past year were no different from what the city had seen in the previous 10 years. He was immediately decried as an agent of the outgoing mayor who lost the elections. More digging around by other external journalists corroborated his claim that crime rates had not really increased - this year was just as bad or as good as the previous 10 years. This got everybody in the city puzzled, until one smart person got to the root of the issue.
A year earlier, the local newspaper got itself a new editor, who appointed a full time crime reporter with a brief to cover and report all crimes in the city. His view was that crime sells, and that reporting and sensationalizing crimes could boost circulation of his newspaper. Crime beat, which was previously tucked into a small column on page 5, now began coming into the front page, with photographs, victim interviews, views of neighbours and opinions of prominent citizens. Suddenly, the city looked like it had become the crime capital of the country. In reality, nothing had changed. But perceptions of the citizens changed dramatically, with what was shown to them so vividly by the newspaper.
Human behavior has not changed, though times have
Maybe today, with so much more media and so many more sources of information, a single newspaper may not be able to shape public opinion the way this story suggests. But, human behavior hasn't changed. When confronted with the need to make a decision, we decide on the basis of data which most readily comes to our mind. And that which usually comes readily to mind is what has been supplied to us most recently, and which caught our attention. There is always a danger that such decisions may not be the best ones to take, as good decisions are usually those that are taken after careful consideration of all relevant facts and not just a selective set of facts that we recently came across.
Behavioural scientists call this process of making decisions as one that is impacted by "Availability Heuristics".
What is Availability Heuristics?
Wikipedia defines availability heuristics as follows : "The availability heuristic is a mental shortcut that relies on immediate examples that come to mind. The availability heuristic operates on the notion that if something can be recalled, it must be important. Subsequently, people tend to heavily weigh their judgments toward more recent information, making new opinion biased toward that latest news"
Wikipedia goes on to elaborate on this concept further in this manner : When faced with the difficult task of judging probability or frequency, people use a limited number of strategies, called heuristics, to simplify these judgments. One of these strategies, the availability heuristic, is the tendency to make a judgment about the frequency of an event based on how easy it is to recall similar instances. In 1973, Amos Tversky and Daniel Kahneman first studied this phenomenon and labeled it the Availability Heuristic. The availability heuristic is an unconscious process that operates on the notion that, "if you can think of it, it must be important." In other words, how easily an example can be called to mind is related to perceptions about how often this event occurs. Thus, people tend to use a readily accessible attribute to base their beliefs about a relatively distant concept.
In the fictionalized story of the US city that we discussed above, the citizens fell prey to "availability heuristics" in coming to a conclusion that crime rates in their city were soaring. Front page news, with all the gory details and pictures of every crime in the city, made the citizens feel that they are constantly under attack. The same crimes, when reported in an obscure corner of the same newspaper in a bland tone, didn't attract attention, and therefore didn't fuel perceptions. Before coming to a conclusion that the city was not safe to live anymore, a rational decision making process would have meant studying patterns in crime rates over the years and looking for hard data to corroborate a feeling that crime is spinning out of control. The reality is that few of us do this. We tend to come to our conclusions on the basis of information that is readily and conveniently made available to us.
Availability heuristics in the world of investments
Think of what goes on in your clients minds when they see a headline which screams "Rs.100,000 crore of investor wealth eroded in market carnage". Reproduced here is one such piece - written in May 2004, when the market corrected briefly and sharply before going on to produce the biggest bull market we've seen in recent times.
"Rs 100,000 crore lost as market falls
The Left parties' demand for scrapping the divestment policy before the formation of the government at the Centre played havoc on the bourses, wiping out a market cap of over Rs 1,00,000 crore (Rs 1,000 billion) and the BSE Sensex tumbled by a huge 330 points to end at 25-week low at 5069.87 on across-the-board sell-off by investors.
The market also witnessed the biggest intra-day fall in four years as the foreign institutional investors battered the PSU and banking stocks in a knee-jerk reaction after the Communist Party of India-Marxist and Communist Party of India made it clear that the divestment policies should be scrapped.
The market's intra-day swing of 372.05 points is the fifth largest in the Bombay Stock Exchange history. The previous record was on May 2, 2000 when the market gyrated in the range of 393.17 points."
http://www.rediff.com/money/2004/may/14market.htm
You would expect any investor who read this back in May 2004, to have got rattled by this news, to have worried about investments he had already made and to have firmly decided against making any fresh investments into a market that was in meltdown mode. When the newspapers scream about wealth evaporating, when TV channels lend their full support to this sensational news of a market meltdown, what chance do you have of being heard when you suggest to your clients that this is indeed the best time to buy? What chance do you have of your client patiently going through a graph you show him of how PE multiples are now flashing a buy signal? Some advisors have succeeded in their efforts to wean their clients away from falling prey to availability heuristics and towards more balanced and rational decision making. But, the story of most investors continues to be one of making investment decisions using availability heuristics - making decisions based on the most recent information that is most readily and conveniently made available to them. This is what causes them to buy high and sell low, rather than doing it the other way around.
Don't we all fall prey to this kind of behavior?
There is little merit in blaming investors for getting carried away with sensational media reporting of market events and therefore taking illogical investment decisions. Most of us are perhaps guilty of getting carried away by media reporting on other facets of life that we are less familiar with - politics and government for example. How many of us have actually done independent research on claims that politicians make against each other in an election season and come to our own data based conclusions?
As Daniel Kahneman, the proponent of the availability heuristics theory succinctly observed, "Experiments show that people react favourably to words that are repeated to them. A reliable way to make people believe in falsehoods, is frequent repetition, because familiarity is not easily distinguished from truth. Authoritarian institutions and marketers have always known this fact."
From our perspective of advising our clients and helping them take more rational and data-based investment decisions, it is not falsehoods that we are up against. It is well packaged media hype that we need to counter. How can we do this? The answer perhaps lies not in countering availability heuristics, but using it.
How can we help investors see reason rather than falling for hype?
There are three key insights that one must remember on how availability heuristics works :
We make a judgment based on what we can remember, rather than complete data Although a dull, unexciting event may be more common, vivid and more dramatic events come to mind more easily Individuals react favourably when they are "primed" - when they have been put into a frame of mind that influences a particular decision
Lets go back to the case of you meeting your client the day after a market meltdown. He has 3 newspapers in front of him screaming headlines of wealth erosion, he has a business channel on in his TV which shows realtime the market in a free fall. And, in this situation, you try to persuade him to buy with a pitch on how PE levels are now very attractive. The reason you are perhaps unlikely to succeed is that your client has already made a judgment before you began the meeting, based on information readily available with him, and therefore does not want to consider your data. He has already been "primed" by the media into making a decision. And, the media's rendition of its carnage and meltdown stories is far more catchy, for more "exciting" than your dull and dreary monologue on PE levels.
If you are to try and turn things around, you may want to consider something along these lines :
Use graphs, charts, colours and symbols to showcase inexpensive and expensive markets. The traffic lights symbol used by a couple of fund houses is a good example of a more visually appealing format to represent your data. "Prime" your clients - by sending them at least a monthly update on these traffic lights or symbols. Make sure you remind them every month about what the traffic light or other symbol is currently flashing. Keep this process on every month - because you know that it is your job to make this information constantly and readily available for your client, if you expect him to use it in his decision making process. If indeed you are constantly updating your clients in a visually appealing manner about market valuations, you can be reasonably sure that when the market falls and your symbol is flashing a buy, he would be much more willing to go with the buy signal rather than the morning's paper which proclaims a market meltdown. You have "primed" him in advance, before the media could reach him with the latest news bulletin with all its sensationalism.
A good way to blend this approach with an asset allocation approach could be to use a strategic and tactical allocation, where you go tactically over or underweight based on what your symbols and charts of market valuations are flashing. Be sure not to talk about PE levels, focus on what the PE level means in terms of buy / hold / sell signals. If you want your clients to remember what you want them to remember, say it often and communicate it in a visually appealing manner.
All content in MasterMind is created by Wealth Forum and should not be construed as an opinion of Sundaram Mutual Fund.
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MasterMind is a joint initiative between Sundaram Mutual and Wealth Forum, in which we offer insights into how you can become a more effective advisor to your clients, by understanding them better, understanding how they think, understanding how they take financial decisions. This gateway into your clients' minds we believe will help you relate better to them, communicate more effectively with them and thus serve them better. Mastering your client's mind is your gateway to becoming a more successful advisor. Its not for nothing that they say, "Its all in the mind!"