The placebo effect is both fascinating and real, with compelling evidence of its impact in both a medical and marketing context. Whilst it is in these areas that discussion around placebos tends to focus; the notion that something can make us feel better, even if there is no logical reason for it do so, seems relevant to much investment activity.
The definition of the ‘placebo effect’ from Google is as follows:
“A beneficial effect produced by a placebo drug or treatment, which cannot be attributed to the properties of the placebo itself, and must therefore be due to the patient’s belief in that treatment”.
We can reframe this slightly and create an ‘investment placebo’:
“A beneficial effect felt by an investor by a certain investment activity, which is unlikely to be attributed to the properties of the action itself, and must therefore be due the investor’s belief in that activity”.
What kind of activities might be captured by the above definition (not a definitive list):
– Short-term trading / market timing.
– Trading on macro-economic news.
– Performance chasing in active mutual funds.
The idea of an investment placebo is somewhat distinct from that which is widely discussed in medicine[i] or marketing[ii] – the activity or treatment undertaken in investment is not designed to be inert, rather on average such activities are likely to have a negligible or, indeed, negative impact. Furthermore, placebos in other areas can actually deliver positive end outcomes – patients can experience improved health following such treatments and consumers get greater enjoyment from drinking a more expensive wine. In investments, these ineffective activities do not assist in us meeting our end objectives, but simply make us feel better at the time they are administered.
But why do certain investment actions make us feel better, even when there is limited evidence that they will have a positive impact on our long-run outcomes? There are a multitude of factors at play here, but one interesting notion is the idea of an action bias, the phenomenon where in certain situations opting for action over inaction is heavily favoured. As an example of this, a group of psychologists studied the behaviour of goalkeepers during penalty kicks in football (soccer) and found that goalkeepers tend to jump left or right in order to save the penalty, wherein the optimal strategy is to stay in the middle of the goal[iii].
The researchers in the study argue that the tendency of the goalkeepers to dive in a certain direction is because the norm is for action, and their experience of a bad outcome (conceding a goal from the penalty kick) would be worse if they had ignored the norm and simply stood in the centre of the goal. It would appear as if they did not take any action to prevent the bad outcome.
Now, I think there is a problem with this study – it argues that the best decision for a goalkeeper is not to move (they would save more penalties if they stood stock-still). This is, however, founded upon the assumption that the penalty taker has not decided to kick the ball into the centre of the goal after seeing the goalkeeper move first. In fact it is common for high quality penalty takers to wait for the goalkeeper to move and then strike the ball.
Even with this caveat*, the study makes a valid point about behavioural norms and how, in certain situations, we will view the simple act of doing something more favourably than doing nothing, despite there often being no compelling evidence that such activity will be beneficial to us.
In the investment industry, it seems irrefutable that there is a preference for action over inaction – amidst the incessant newsflow, erratic price fluctuations and obsession with the latest headline risk, the urge to do something can be irresistible – what if I miss out? What if things go wrong and I have done nothing? How can I just sit here when all of this is happening? What will clients think?
The stress and anxiety created by such an environment mean that actions of questionable validity (on average) can prove a powerful short-term ameliorative – making changes based on what is happening now will likely feel good, for a time. The problem is they will often come at a long-term cost.
* Never let reality get in the way of an academic reference.
[ii] Shiv, B., Carmon, Z., & Ariely, D. (2005). Placebo effects of marketing actions: Consumers may get what they pay for. Journal of marketing Research, 42(4), 383-393.
[iii] Bar-Eli, M., Azar, O. H., Ritov, I., Keidar-Levin, Y., & Schein, G. (2007). Action bias among elite soccer goalkeepers: The case of penalty kicks. Journal of economic psychology, 28(5), 606-621.
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