What bad design can teach us about investor behaviour

Shower controls and Jet Lag

I am currently reading a book on design called The Design of Everyday Things by Don Norman. As opposed to the usual sources of reading recommendations from friends, websites top 10s or the ubiquitous Amazon recommendation engine, I came across this book when letting off frustration on google. Let me explain.

For a long time, my professional designation was “management consultant”, a profession that gets its fair share of eyerolls and wisecracks, not unlike…

“If you see a consultant on a bicycle, why should you never swerve to hit him?

It might be your bicycle.”

A regular part of my job meant flying to various client locations and spending large parts of work weeks in hotels. Now, I didn’t mind hotel rooms for the most part, except when it came to the showers, to be precise, hotel shower controls. Bleary eyed from waking up in a different time zone, I’d go into the shower, to then stare blankly at the gleaming polished metallic contraption on the wall, not unlike this one.

How was one to figure out the right setting to avoid being blasted by a jet of scalding hot or freezing cold water? When the water flowing from the tap still feels cold after I set it to what seems right, is it because it takes a while for the heating to kick in? Am I the problem? Should a comfortable shower need a PhD.?

I’d mostly get it with a bit of trial and error, but there was this one time, that I just couldn’t. No matter what I did with the various knobs, freezing cold water kept gushing out. The prospect of not washing off remnants of a 10 hour plane ride made me steel myself and shower in the ice cold water. Later that day, I punched irately into google “Why are shower controls so badly designed?” which took me to an article referring to Don’s book.

The three levels of cognition

I started reading the book recently, several years after adding it to my mental reading list, and quickly saw why it’s considered necessary reading for anyone building products or services for other people, i.e. an understanding of how the human mind thinks, feels and reacts is essential to building great user experiences. And how there are implications for investors, from how our minds react to information.

There are different models about the working of the human mind, my all-time favourite being the seminal piece of work Thinking, Fast and Slow by Nobel winner Daniel Kahneman. The design of everyday things puts it as three levels of cognition:

  1. Visceral: the “lizard brain” – basic protective mechanism – quick judgments about the environment – good / bad, safe / dangerous – enables quick response without conscious awareness
  2. Behavioral: home of learned skills – triggered by situations that match appropriate patterns – largely unconscious actions, like picking up a cup, balancing a tray
  3. Reflective: home of conscious cognition – deep understanding and conscious decision-making takes place – cognitive, deep and slow

The author goes on to summarize the significance of the distinct thought process:

“Reflective memories are often more important than reality. If we have a strongly positive visceral response but disappointing usability problems at the behavioral level, when we reflect back upon the product, the reflective level might well weigh the positive response strongly enough to overlook the severe behavioral difficulties”

How financial news hijacks the Investor’s mind

So what does all this have to do with investing? Plenty it turns out.

Let’s do a thought exercise. Take a look at the image below, glance at each of the images forming a composite representing a declining market. Look at it for a few seconds. Imagine this to be a summary of “information” you receive over a few days as markets decline.

What is the immediate unfiltered sensation you feel? If possible, write down a few words that describe that feeling before reading on.

The Calm Investor | Market Crash News

Now do the same with this image. The idea being to document the immediate feelings that surface when faced with this information.

The Calm Investor | Optimistic Markets

If you’re like most people, here’s the likely outcomes of the three levels of cognition. Read the 2nd and 3rd columns (reactions to the images above), as a sequence of thoughts and feelings arising in the investor’s mind and the resulting action, followed by the “rationalizing” of it all as she looks to make sense of the events.

These assume to be the reactions of a largely “invested” investor, who has a fair part of her portfolio invested in stocks. The reactions would be very different for a beginner who has not invested anything yet.

Typical Investor Response
Reaction #1. Market Crash Imagery #2. Optimistic Market Imagery
Visceral (Immediate reaction) Unease, Discomfort, Heightened pulse rate Upbeat, Confident
Behavioral (Immediate action) Slight panic about portfolio, "Surely no more buying", "Sell everything?! Am I holding too much cash? Deploy quickly!, "Buy on dips!"
Reflective (Rationalization a week later) Stocks are just too risky. Should have stuck to real estate. More bonds and FDs from now on I am a brilliant investor! Should have more conviction and buy more when I'm convinced. Liquidate those bonds to allocate to equities? Mention portfolio at the next party. Think about what colour would look good on you in your CNBC interview.

Calling in hostage rescue

Financial news channels are not badly designed. Not if you’re running the news channels to keep viewers from changing channels by eliciting extreme emotions. Their ad revenues are tied to viewership ratings and they would like you watching, either in open-mouthed horror, or in a smug self-congratulatory mood.

Ergo, let’s be aware that financial news channels are incredibly poorly designed for good investor behaviour.

Why the reaction to Market Crash Imagery

That visceral response to doomsday headlines and the red-soaked CNBC ticker triggers primal aversion to loss bias which makes us fear losses twice as much as equivalent gains.

A rush to minimize notional losses makes us consider realizing the losses just to ease the discomfort of facing the prospect of further decline in portfolio value. This could mean stopping SIPs just when stocks are getting cheaper and even selling at the wrong time, when even quality stocks are getting beaten down as a result of the overall selloff.

Why the reaction to Optimistic Market Imagery

Big smiles on the faces of good-looking anchors, ticker awash in green and uplifting macro forecasts. What more can the market need!

All the holdings showing smart gains, even the ones you bought only a few months ago. Your self-assessment of your investing prowess is only being confirmed. Your fear of missing out (FOMO) will make you justify excessive valuations and to deploy any remaining cash, and fast!

What the investor can do:

  1. Stay away from the constant barrage of information. Don’t drink from the fire hydrant.
  2. Think long term. Which is when equities outperform other asset classes
  3. Make it a point to not take action when feeling a lot of emotion. Here are 8 rules value investor Guy Spier applies

Finally, how the Calm Investor reacts to market news

The Calm Investor Response
Reaction #1. Market Crash Imagery #2. Optimistic Market Imagery
Visceral (Immediate reactions) Some Unease, Heightened pulse rate Lot of unease, "Too much too soon?"
Behavioral (Immediate action) Slow down, let's not make decisions now, Turn off the news. Give it a few sessions. "How much more attractive are my favourite stocks looking?" Slow down, let's not make decisions now, Turn off the news. Give it a few sessions. "No lumpsum buys at this time". But, continue SIPs since I don't know what's coming.
Reflective (Rationalization a week later) Increase SIPs, Time to get busy, identify bargains. Buy more of the most beaten down quality stocks.  "I'm not a bad investor!" Rising tides lift all boats. Let's not talk about my winners. Carefully go stock by stock to determine whether they're significantly over-valued. Reduce if appropriate.

After all, “Life is 10% of what happens to us, and 90% of how we react to it.”

Further Reading:

More one-liners about management consultants here (Obviously, I endorse none of these)

The lifehacker article – Life is 10% of what happens to me, 90% of how I react to it

 

6 thoughts on “What bad design can teach us about investor behaviour

  • September 29, 2016 at 11:04 am
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    Just discovered your site via your comment on subra’ s blog. Nice article. Your site seems to have the right look, feel and content to converse about investing in India. Most Indian blogs are not well-written due to lack of writing skills and your blog seems to be a happy exception. The most empirically useful books on investment & behavioural biases are invariably American – think William Bernstein, John Bogle, Burton Malkiel, Charles Ellis, Kahneman et. al., but we do not find too many bloggers reflecting on & applying their lessons to the Indian context. You seem to do it filling up the niche, so more power to you. Best wishes and looking forward to similar insightful articles.

  • September 29, 2016 at 11:22 am
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    Thanks for the kind words Sai. You’re spot on about a lot of literature on investing, especially value investing is set in an American context, most of which, but not all, is applicable in India. Would love your feedback on other posts here, what you find missing, what could be better covered, any and all inputs are welcome.

  • September 30, 2016 at 8:58 am
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    Interesting article. Exposure to media has a lot of potential to make us emotional and react, esp. the deadly combination of audio and visual clips about any incident tend to scare us or make us too excited and we may force us to do something. Not just financial, but also social content does the same.
    Knowing this may help us to control ourselves in such situations!

  • September 30, 2016 at 9:09 am
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    Agree Srinivas. strong stimuli cause us to react in ways that are not ideal and it’s useful to be aware of this tendency our brains have.

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