Daniel Kahneman discussed the availability heuristic – when people make decisions based on the availability of an example which easily comes to mind but which may be heavily swayed by emotion. Emotional things often come most easily to mind because the brain is made to protect us from adverse effects. Therefore, if you burn yourself as a child, you remember that event clearly for a long time and are cautious from then on. Even if you only burnt yourself that one time and it was ten years ago. That is a protective emotional response to a real and possible threat but other events may be very rare (something you saw on the news) and very unlikely to ever effect you nevertheless, it made a big emotional impact and may quickly come to mind and sway your opinion or decision/action inappropriately in the future.

This may been seen in the behavior of investors in the stock market after the 2008 crash. Some people emotionally ripped their money (what was left) out of the stock market, rather than calmly leaving it alone until the market rebounded. Years later, people still feared putting their money into certain investments because they remember the crash. Also, the Brexit or the night that Donald Trump started winning the presidency – the stocks started to plummet. These were people behaving emotionally rather than logically to the news.

The stock market has a long history of being immediately influenced by news stories. The availability heuristic is influenced by the availability cascade  which is when the media and public opinion grow off each other and guide decisions and resources, often for their own benefit, referred to as “availability entrepreneurs“, such as for ratings or politics (p. 142). The result can lead to non-expert opinion being guided by emotion vs. expert opinion being guided by real statistical risk. These opinions can guide government policy, correctly or not, for good or bad. So, although public opinion may be strong and heavily influenced by emotion rather than facts or actual risk – it can move government policy in it’s direction and millions of dollars may be spent unnecessarily… other than for calming the people which may have it’s own worth in the long run.  As far as market effects go, Kahneman goes on the discusses the inability of our brains to “deal with small risks“, tending to “ignore them altogether or give them far too much weight – nothing in between”(p. 143).

These small risks vs big risks seem to be leveled by time. Closer to 2008, the risks to investing in the stock market seemed steep but grows smaller the farther out we get. Maslow’s Hierarchy of Needs also comes to mind, as investing in the stock market or any investment is a reflection of security – financial security. At the base of Maslow’s hierarchy are psychological needs such as food, water, and sleep. The next level above that is safety, some say safety and security. These include things like, family, health, social stability, employment and property. This is the level that I think investments or financial security fall under. Which makes it one of the very basic of human needs- level 2. Above those two levels are three levels: love/belonging; esteem; and self-actualization. As you fulfill the lower levels of the pyramid of needs and go up the pyramid it seems there are more resources to then go back down the pyramid and reassess when needed. This type of multilayer support system can also effect one’s perceived risk or comfort with investing – whether to invest (safety and security for yourself, your spouse, your children) and what to invest in (self-actualization – riskier returns based on beliefs such as, solar vs. oil). Esteem may also influence people’s perceived risk of self-esteem vs. financial benefits of investment if they want to be perceived as rich or skilled at investing and creating money from their money (having their money work for them).

This influence of esteem on investment risk may really bring us into the realm of Motivation psychology.  Are they internally or externally motivated?  If they are highly externally motivated and/or surrounded by people who value money over anything else then they may be more inclined to invest in riskier investments in the hope of making lots of money fast. Their perceived risk of not fitting into the particular group (however personally defined) is more threatening and emotionally upsetting than the risk of loosing money.

This concept of emotional returns over actual losses also crosses over into gambling and cognitive psychology. The gambler’s mind releases dopamine with the excitement of the the risk and little wins release more dopamine and reinforce this behavior of taking risks. This person is likely to start playing the stock market and relishing it’s wins and discounting it’s losses – at all costs. Which reminds me of Kahneman’s comment about the inability of our brains to “deal with small risks“, tending to “ignore them altogether or give them far too much weight – nothing in between”(p. 143).

 

Reference

Kahneman, D. (2011). Thinking Fast and Slow. New York, NY: Farrar, Straus and Giroux.