Let me begin this with “Volvo Story” – this was presented by Amos Tversky.
A colleague of Amos was looking to purchase a new car and was considering Volvo. Consumer reports showed through independent tests that Volvos were among the best built and most reliable cars in their class. Customer satisfaction surveys showed that Volvo owners were far happier with their purchase after several years. The surveys were based on tens of thousands of customers. The sheer number of people polled meant that any anomaly – like a specific vehicle was exceptionally good or exceptionally bad will be drowned out by all the other reports. This made the survey reliable and very useful input for decision making.
Amos ran into the colleague a week later and asked him how his car purchase was coming along. The colleague decided against Volvo in favour of a lower rated car. The reason was the colleague spoke with his brother-in-law who owned a Volvo and he had a poor experience as it needed significant maintenance regularly.
Strictly speaking, the colleague’s decision was not entirely rational. His brother-in-law’s experience represents single data point which should be ignored in the presence of data from tens of thousands of other users. His brother-in-law’s experience is an outlier. But we are social creatures and are easily swayed by first person stories and vivid accounts of a single experience.
This bias of being swayed by first person stories leads us into tricky situations where we tend to ignore the statistical average, especially in investing world. In investment space this is also muddled by people who tell stories are usually talking about extremes – the killing they made on a specific investment or money they lost by doing something. Predominant bias is towards telling success stories (we all love to talk about our “wins”).
Let’s look at some examples
- Indian investors have less than 500 cr in NIFTY index funds and over 180,000 crores in mutual funds. Almost all Mutual funds underperform NIFTY over a 7 year period and very few beat NIFTY over a 5 year period. But mutual funds with their higher margins are able to tell a much better story and incentivise various retailers to push their products. Most retail investors are not aware of opportunities in investing in Index and invest in mutual funds – many of which make money only for the fund house and fund manager.
- All of us hear about people making a very good return (way above average) by purchasing a home. Almost anyone who can afford a home has one and some have more– so it is statistically impossible for “everyone” to beat the average by doing what “everyone else” is doing. Statistically half the people are going to be disappointed – it’s just that everyone believes that they are in the “other” half.
- Some of my social conversations veer into investments. I always find that discussing a specific stock (read “stock tips”) creates a lot more interest than a discussion about steady investment over long term to build wealth. Stock tips have a greater chance of not working out where as steady investments over a long term (though boring) have a much better chance of building wealth.
We should remember that we have a bias towards stories and we tend to ignore statistics. Relying only on stories and ignoring statistics could lead us into sub-optimal decisions.
I wish that statistics was as compelling as stories. Sadly it isn’t, but it’s prudent to remember this.