When we talk to each other, especially in the world of investment, we don’t just trade in facts and figures, we put a story around them.
In forming a view about interest rates, stock market direction, whether new IPOs are going to be worthwhile or which stocks represent good buying at the moment, our perspective is based on an interpretation of available facts and figures.
Central banks do it all the time, with jawboning to influence markets views on interest rates and currencies.
This process not only reflects how we communicate but also how we make decisions in the real world, the province of behavioural economics.
In communication, a challenge to the view that all communication was based on reason, or just facts, came from the US scholar, Walter Fisher in the 1980s.
Fisher argued that humans are essentially storytelling creatures – we communicate with each other and make decisions by putting a narrative around facts and figures.
Fisher called this the narrative paradigm and he developed two tests we apply naturally when we hear a story.
One is that of probability – is a story logical and does it make sense – and the other is that of fidelity – does it ring true in relation to what we know.
When we assess company stories in an investment presentation, we essentially put it to these two tests.
So if companies want to influence investment decisions, there’s no point exaggerating or making claims about the future that may or may not be achieved.
This will fail the tests of narrative credibility.
What can be more effective, as recent developments in behavioural economics have shown, is that persuasive presentation of a narrative around facts and figures can nudge people towards a conclusion as well as helping them rely on rules of thumb to make sound judgments.
Kahneman’s Thinking Fast and Slow points out that humans can make mistakes by placing too much confidence in their own judgement – they rely on fast instead of slow thinking which means they short cut hard decisions.
This leads to an optimism bias anchored in their concept of WYSIATI – what you see is all there is – which tends to overlook the unforeseen.
Kahneman’s work inspired Thaler & Sunstein to write Nudge, in which they highlighted that the flaws of fast thinking can be overcome with the right incentives, since people can be nudged into decisions that are good for them.
Overturning both these behavioural perspectives is a new book by Gerg Gigerenzer, Risk Savvy, which argues that classifying thinking as fast and slow is too pessimistic.
Humans are actually far more capable of making the right decisions , and we don’t need paternalism to nudge us in a particular direction.
Good decisions come out of relying on gut feeling – reinforced by rules of thumb, understanding probability and absorbing the story around facts – and good communication can influence these decision factors.
In one experiment about the best stocks to invest in, Gigerenzer stopped pedestrians at random and asked them which companies they’d heard of – what he called a “recognition heuristic” provided a correlation between performance and prominence that made money for him.
Gigerenzer also cites Nobel Prize winner, Harry Markowitz, who, despite having invented risk weighted decision making in investment, when it came to investing his own money, simply divided his funds equally across several assets so he wouldn’t have too many eggs in the one basket.
One of Gigerenzer’s tips about risk is simply not to buy financial products you don’t understand, which ties in with Warren Buffet’s investment advice and also Fisher’s tests of narrative credibility.
The lesson from all this for investor relations is that, while facts and numbers are important, it is the story around them that ultimately influences investment decision making.