Heuristics – a subject The Value Perspective likes to revisit from time to time – are mental rules of thumb developed over many millennia where the human brain sacrifices intellectual rigour for the sake of reaching a speedier decision. Indispensible when it came to dodging sharp-toothed predators in the early stages of our evolutionary history, heuristics can be less helpful in a modern investment context.
One type of heuristic the behavioural finance fraternity can find tricky to explain is the ‘affect heuristic’, where people’s likes, desires and other emotions influence what they believe or how they think about the world. It may, for example, explain why, for more than 40 years, bookmakers have made a fortune from football fans betting on England winning a major tournament.
Sticking with the world of football, here is a more specific illustration from recent personal experience of the affect heuristic in action. At the start of the month, some friends and I visited Barcelona for the weekend and, before we went, one of our party checked the weather forecast.
Finding the forecast too rainy for his liking, he decided that it was likely to be wrong, and so checked another forecast, then another – and kept going until he found one that indicated the degree of sunshine he felt befitted a short break in Spain. He allowed his desires to affect his view on the likelihood of a forecast being accurate, and then packed accordingly. The end-result of which can be seen in the photo below of him ‘enjoying’ a football match at the magnificent – and, on that evening, sodden – Nou Camp stadium.
The affect heuristic can also have unpleasant consequences when it comes to picking stocks due to liking a management team, sector or investment theme. A strong value discipline can help to prevent the need for the investment equivalent of relying on the kindness of a stranger for a makeshift poncho on a night of torrential rain.