Dan Ariely, the James B. Duke Professor of Psychology & Behavioral Economics at Duke University is one of the most foremost authorities on the topic of Behavioral Economics, and his work is extremely informative for investors who are looking to understand why the financial markets and global economy act the way they do.

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In an interview published in the July 28 issue of Goldman Sachs’ Fortnightly Thoughts magazine, Dan discusses some of the irrational behavior traits that affect investors and why in today’s globally connected world, investors need to extremely careful not to damage their investment performance by irrational emotional behavior.

Behavioral Analysis

These are the highlights of the interview, which was first published in April of this year.

Dan Ariely: On competitive advantage

Competitive advantage and the economic business moat that comes with such a position is the basis of the long-term buy and forget investor’s strategy. But today, company lifespans are getting shorter and shorter as disruptive forces such as the internet are rapidly changing the market. Brand loyalty is falling away, and consumers are increasingly offered products of a similar quality lower price.

Nonetheless, Dan Ariely believes that some of the best brands will continue to stand the test time due to the signalling effect they convey:

“When I say Sony or Apple or Porsche, you already know something about those companies, what their product is, what they stand for etc. And from that perspective, given that we don’t have access to all the aspects of the product in the online world, brands can actually become more important.

Brands are also tools for signaling to yourself and other people. So if I wear a fancy undergarment, I feel different about myself because of it. This signaling effect works to the extent that brands are often important to determine both what I think of myself and what people think of me.

And so, the brands that will get eroded in the digital world are those that convey information that you can get elsewhere. For example, if there was a brand for big and small hard drives, it is likely to become less important as you can easily describe the product in other ways. But for brands of products that we can’t experience online or those that are used for signaling are unlikely to go away; such brands might get even more powerful.”

Unfortunately, the opposite is happening in the financial industry. Investors shopping for the best deal on financial advisory services are faced with hundreds of options when there are so many options to choose from; people just resort to simplified strategies, which may not necessarily have the best economic outcome for them.

“Take financial decision making for instance. People seek financial advisory services for say a 1% fee, which is an incredibly high cost to pay in order to not deal with the complexity of making investment related decisions.”

Neither may be best to seek financial advice from crowds:

“Sadly, there are many cases when we ask people for feedback on things they have no expertise on. And so, the wisdom of the crowds is not always correct when the crowd does not have much idea on the subject or if they have some biases.”

As the world becomes more interconnected and social media plays an ever-increasing role in daily-two-day life, separating the incorrect crowd opinions from those of experts and trying to reduce the influence of social media on our investment decisions is going to become harder.

“As we get more and more information, it is increasingly harder to be experts on everything. And so, we rely more on what we think is right rather than something that we have the time to figure out for sure. And so, the role of social media is getting bigger and therefore the kind of media we get exposed to will influence what we think dramatically.”

Something for investors to keep an eye on.