Our brains are pretty smart, so they use shortcuts to make it easier to analyse information. But sometimes these shortcuts can catch us out, especially when we’re investing, explains investment adviser Sheryl Sutherland.
Sometimes these shortcuts drive the brain to give us an answer to a problem before we’ve fully digested all the facts.
One of these ‘short-cuts’ is called ‘representativeness’.
Take this test
In representativeness, the brain assumes that things which share similar qualities are alike – it’s our capacity to think in stereotypes.
Consider this: Miss Perkins is quiet, studious and concerned with social issues. She has an honours degree in English and a Diploma in Environmental Studies.
Given this information, which of the following statements is the most likely:
1. Miss Perkins is a librarian.
2. Miss Perkins is a librarian and a Greenpeace member.
3. Miss Perkins is a banker.
When asked this, more than half of the respondents chose ‘2) Miss Perkins is a librarian and a Greenpeace member.’
What assumptions did you make?
They selected this answer because it’s the sort of career we think is most likely to be selected by a studious person concerned with the environment.
Around a quarter of all respondents selected ‘1) Miss Perkins is a librarian’, understanding that 2) is a variant or subset of 1).
However, more people are employed by banks than by libraries, so it’s more likely that Miss Perkins works for a bank than a library.
Our brains haven’t chosen 3) because the banking industry is not what we think of as ‘representative’ of someone with Miss Perkins’ skills and interests.
It’s not just ordinary people who make these assumptions. It’s also experienced academics.
A series of surveys of economics professors concluded that their estimates were consistent with the notion that the most recent past is representative of what will happen in the future – you’d think they’d know better.
First published 21 December 2018
Story by Sheryl Sutherland
This article is part of the Rational Investor series by Sheryl Sutherland. Sutherland, of the Financial Strategies Group, is an investment adviser who has worked in the industry for the past 30 years. She’s also the author of several best-selling books.
A full disclosure is available by contacting email@example.com
This article does not contain any financial advice and has not taken into account any particular person’s circumstances. Before relying on it, we recommend you speak with a financial adviser. This story reflects the views of the contributor only. Content comes from sources that we consider are accurate, but we do not guarantee that the content is accurate.
Sign up to our newsletter to receive the latest news, updates and event invites from JUNO investing magazine.