Beware of Investment Stories Bearing False Comfort
Narrative offers a way for us to understand facts and events. The trick is recognizing when we are being led astray.
Bloomberg, April 19, 2017
As regular readers know, the cognitive errors that investors make are regular fodder for discussion in my columns. I spent years trying to understand these mistakes, which eventually led me to the worlds of psychology and neuro-finance.
Yet my critics often say I am guilty of the same sort of narrative fallacy that I so often write about.
To which I plead, “Guilty, but with a difference.”
There is no doubt that the tale of why people rely on narratives is itself a specific narrative. But obviously we need to draw a distinction between narratives that enlighten versus those that are used to mislead or confuse.
Consider some of the subjects we have tackled here in the past.
We have looked at market narratives in stock stories; that is the most obvious example. From the endowment affect to hindsight bias, this may be the most common sort of narrative fallacy afflicting investors. Be it about specific stocks or the overall market, we are easily distracted and misled. However, the narrative approach to fooling people knows no limits.
Other subjects are just as ripe for story-telling to create a false understanding of events. Take politics: There seems to be a constant stream of political narratives — about the presidential election (both before and after Nov. 8), about the post-election stock-market rally, about the middle-class falling behind, even about the now-infamous alternative facts.
This often bleeds into economics. For example, over the years we have seen any number of silly conspiracy theories about the jobs numbers being cooked. If you believe economics matters to investors, this might be a big deal. But the reality is that data on its own is confusing enough, and it does no one any good to indulge in nonsense about manipulating the results.
Then there are multiple false narratives about the financial crisis — there even have been misleading tales about movies about the financial crisis. There are false narratives about the war on coal, about financial models, about gold — the list is long.
All of this storytelling creates a huge amount of distracting noise for traders and investors. Narratives are seductive because they impose a sense of rationality on unexplained events; this allows us to be more easily fooled by what is probably random and meaningless activity. No one wants to admit that chance plays such a large role in events; acknowledging this truth would undermine our delusional self-image of being skilled, informed and in control.
Using the science of storytelling to discuss behavioral economics has one significant advantage: It’s accurate. It is based of years of observation and testing; this approach isn’t especially flattering to our species, and thus less likely to be appealing for reasons of ego.
Yet bad narratives persist because they actually do what they are meant to do — provide a sense of comfort amid events that we have trouble understanding. While there are broad ramifications for these errors in fields such a politics or religion, when it comes to finance there often is an economic cost as well. That is why I find the topic so utterly fascinating.
Thus, using a narrative to tell a story for readers — most of us have an easier time understanding a story with a beginning, middle and end than a set of random facts — is quite different from using a narrative to offer a false but comforting tale. Despite the inherent failings and limitations of our wetware, I believe readers are smart enough to understand that difference.