Each of us craves a good story. Imagine you’re at a dinner party and your friend shares this story,
“I invested $72,591 in a stock that tripled in value within a week. I sold the stock yesterday and it’s paying for all three of our kids to attend college.”
It’s an inspiring story and it may even be enough for you to go out and invest tens of thousands of dollars in a single stock option in search of that same windfall. This investor behavioral bias is simply called “Preferring Stories over Data”. Research proves that anecdotal data carries a much stronger influence that empirical information, as detailed in the excellent work of Wainberg, Kida, and Smith. There’s no debate the exceptional power of a success story, but the context of empirical data to support the story’s success is of equal importance.
For example, we hear a story of success involving a risky investment and it’s easy to think, “That could be me. If it worked for my colleague, is there really such a risk to my own investment?” Data shows that single-stock investments can often experience 30 percent or higher in value change. (InvestorGuide) While some investors may prefer the “high risk, high reward” premise of single stock investment, the safer investment is often found in the diversity of a mutual fund.
Investors know diversifying your investments is one of the cardinal rules of financial planning; this wisdom is ingrained in the mind of any seasoned investor. However, being patient through long-term investment growth doesn’t carry the thrill of seeing a single stock skyrocket. If you choose volatile investment options on the basis of one success story, you run the risk of being the norm, not the exception, that follows the investment’s negative reputation.
Having an objective outlook while researching and analyzing data can be difficult but it will often save you from the rollercoaster of a volatile investment. It may be helpful to consider this question when facing a potentially risky investment, “What is the story I’m more likely to tell with this investment?” An investment decision grounded in empirical data will largely prevent stories of loss when prudence and data were ignored in search of a good story.