Your memory creates idealized recollections of results obtained in the past
Interview with Paul Smeets (Maastricht University)
Research by Paul Smeets et. al. (Maastricht University) shows that, in making financial decisions, we look at results obtained in the past in an overly positive light. “It is inadvisable to rely on your memory in making decisions. Our study shows that people have a tendency to consistently view investment results obtained in the past through rose-tinted glasses based on their memory of events. This affects the investment choices they will make in the future.”
“We all learn from our experiences, but memories can be selective and distorted”, continues Mr. Smeets. “In our experiment we asked people about their previously obtained investment results. It turns out that they consistently had a more positive outlook on previously obtained results and made more mistakes than non-investors. This is partly caused by selective memory: investors remember their good returns and forget the bad ones.
“Our study shows that preferential memory influences individual convictions and decisions to invest again. Even when this leads to a negative return. And even when participants were offered money to make the right decisions. Memory also appears to take precedence over knowledge of financial markets; it does not matter how much experience or investment knowledge investors have.”
So should investment be avoided altogether? Smeets doesn’t believe that’s wise either: “These days savings have almost no yields and investment can be a valuable alternative. The way in which our memories trick us, provides insight into how people learn from experiences in financial markets and the possible consequences of hubris and taking risks. This information can help you help people make better financial choices.”
Investor Memory by Katrin Gödker, Peiran Jiao, Paul Smeets (UM)