Investing for the wrong reasons: the Affect Heuristic

On page 12 of his outstanding Thinking, Fast and Slow, Daniel Kahneman illustrates the Affect Heuristic – the tendency to make decisions based not on relevant objective critiera, but on the subjective criteria, often irrelevant, of how we feel about the matter at issue – with the following anecdote:

Many years ago I visited the chief investment officer of a large financial firm, who told me that he had just invested some tens of millions of dollars in the stock of Ford Motor Company. When I asked how he had made that decision, he replied that he had recently attended an automobile show and had been impressed. “Boy, do they know how to make a car!” was his explanation. He made it very clear that he trusted his gut feeling and was satisfied with himself and with his decision. I found it remarkable that he had apparently not considered the one question that an economist would call relevant: Is Ford stock currently underpriced? Instead, he had listened to his intuition; he liked the cars, he liked the company, and he liked the idea of owning its stock … The question that the executive faced (should I invest in Ford stock?) was difficult, but the answer to an easier and related question (do I like Ford cars?) came readily to his mind and determined his choice. This is the essence of intuitive heuristics: when faced with a difficult question, we often answer an easier one instead, usually without noticing the substitution.

I was reminded of this anecdote when, while reading through the most recent edition of the Australian Financial Review’s BOSS magazine, which came with today’s newspaper, I came across this anecdote in Tony Boyd’s column on p.14:

The Gresham investor says he stumped up $50,000 in 2004 because [former Wesfarmers chief executive Michael] Chaney was a director of the fund’s responsible entity, Gresham Funds Management. He has $20,000 left.

The Affect Heuristic strikes again.

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About Stebbing Heuer

A person interested in exploring human perception, reasoning, judgement and deciding, and in promoting clear, effective thinking and the making of good decisions.
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