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Dubai: Back to the "doctor's chair" this week for a session with Jenny Bovard, Organisational Psychologist and expert on "behavioural finance".
Bovard's work is part of a "leading edge" trend within the financial services industry, and specifically, the edge that has bloomed since Amos Tversky and Daniel Kahneman's work on "behavioural investing".
Distilling a Nobel Prize into a couple of sentences isn't an easy task, but, to Tversky and Kahneman, investor decision making isn't all that rational.
Indeed, investors generally get disproportionately irked by an investment loss, than they would be pleased by an investment gain. Whilst experienced investors may well display a "balanced" understanding to risk and reward; their emotional reaction to the associated returns and losses are not all that balanced.
If investment advisors could work out the "personality type" of any new investor, in theory, according to Bovard: "They should be able to manage their investor's expectations"; the ideal base for building an advisor/investor relationship.
Confusingly, investors display a number of behavioural and motivational bias areas, according to Bovard, "including: disposition bias; herding theory; and cognitive dissonance.
There are at least a dozen generic areas of bias" says Bovard. Pushed to highlight the most common, Bovard asks: "How many times are you aware that you have explained an investment well, you have disclaimers signed, but when it comes to an apparent performance failure the investor's memory appears "selective"? We call this cognitive dissonance, and it is fairly common," says Bovard.
So what is "cognitive dissonance?" Bovard explains: imagine you are in a psychological experiment. You are asked to do a mind-numbingly boring repetitive task such as filling boxes with reels of cotton thread.
You do your half-hour stint then the researcher debriefs you and asks you to lie to the next subject by stating that you find the work interesting and a lot of fun.
Apparently, such an exercise was conducted with some people being offered $10 to lie and some $100. The experiment ends with the delegates being asked how they really felt about the tasks.
Cognitive dissonance
The rats-on-a-wheel type study confounded research-ers who discovered that the people who were paid $10 to lie, rated the task more interesting than those paid $100.
However, the results helped produce the phenomenon known as "cognitive dissonance". It occurs when people's thoughts do not match their behaviour.
Participants began to lie to themselves about how interesting the tasks were in order to justify the income. There was no other way researchers could justify the "satisfaction" expressed in completing the dull work.
According to Bovard, "selective memory" or cognitive dissonance is most likely to occur when our actions have been freely chosen and when we are committed to the behaviour.
Bovard continues: "The healthy human animal is genetically hard wired to maintain his self esteem. Any suggestion that might contradict our view of ourselves as clever or nice can create this mental confusion, dissonance. No one likes or feels comfortable with cognitive dissonance - it is a very uncomfortable state. So people will go to great lengths to avoid it, deny it or minimise information that conflicts with their positive self image. Sometimes, as in the case of this experiment, they may rethink everything and change their beliefs.
In short then, we will "tweak the truth" in order to satisfy our self-image. But how does this connect with investment decisions?
According to Bovard, "We like to believe that we have done the right thing or made the right decision - how often do you experience this with yourself or your friends? For example, research suggests that horsetrack gamblers who had just made their bet, placed better odds on their chosen horses to win than gamblers who were waiting to bet. Why? Because after betting they change their beliefs in order to be consistent with their decisions."
The affect of cognitive dissonance on investment means that investors can fail to make important decisions as they may find the options and situation too uncomfortable to think about. We all strive for cognitive consistency (a kind of peace of mind) as dissonance makes us tense and irritable, like being at war with our inner selves.
Mood dependence
One example Bovard alludes to is: failing to invest for our old age. For some, retirement and the thought of getting old and not working may be too unpleasant to think about.
Not everyone likes to imagine the loss of youth. Secondly, if an inves-tor filters unwanted or negative information that could create dissonance and make him uncomfortable, he may fail to make adjustments accordingly, to his portfolio, his mortgage, and so on.
Our memories are guided by emotion as well as facts. Research on mood dependent memory shows that when we are in a positive mood we rely more on stereotypes and mental short cuts than when in a negative mood.
Our emotions can also influence memory, and as an animal this helps us to work out which experiences to avoid or seek out in the future, so that we can avoid the painful but seek out the pleasurable.
It was Aristotle in 300BC who claimed that human beings are hard wired to minimise pain and maximise pleasure. Thus investors may try to reduce emotional pain (dissonan-ce) by altering their beliefs about decisions they made in the past.
One may buy into a fund, and as time moves on it is possible that we filter out the negative information coming through on this fund, and instead focus on the positive. This can affect the memory so that we may only remember the good, rather than the bad.
According to Bovard: "Research supports such phen-omena. In one experiment a share, which we will call X, performed worse than another, share Y, but they behaved very differently. X did worse than Y over the year.
However, X dropped very slowly, while Y performed fine but with a deadly drop at the end. This deadly drop caused emotional pain to its investors who perceived it as the poorer investment - an inaccurate judgment. Memory therefore can let us down in failing to recall the past accurately, and, as noted above, a similar thing can happen with pleasurable memories too."
In this way the patterns of a fund can influence how investors buy in the future, based on the tendency to base our beliefs on past decisions (and the need to believe they were correct ones).
Other studies, one actually involving an American association of investors, showed that investors consistently over-estimated the past return on funds that they had bought.
Cognitive consistency (a kind of peace of mind) can therefore be dangerous, since when confronted with contradictory information, the brain's defence mechanisms can filter out unwanted information and alter its memory of such decisions.
Does this mean we are all lying to ourselves in respect of our investment decision-making, I asked Bovard? "No, dissonance does not influence all investing - some people may simply declare they have made a less than average investment and deal with it.
The writer is chairman of Mondial Financial Partners.
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