Every four years (or five thanks to COVID) the Olympic Games offer the world an opportunity to watch athletic greatness from the comfort of our couches. In addition to historically popular events such as Track and Field, Gymnastics, or Swimming there are events such as Artistic Gymnastics, BMX Freestyle and Trampoline. The culmination of every competition is the awarding of medals. The winner receives a gold medal, the runner up a silver medal and the third place finisher receives a bronze. While watching the Olympics can be fun, it can also be informative and can teach us a lot about investing behavior.
In a study from 1995 researchers found that bronze medalists (the third place finisher) had more positive emotional responses to their performances than the silver medalists (second place finisher). The authors of the study were able to determine that each medalist had a counterfactual narrative in their head. Counterfactual thinking is a concept in psychology that involves the human tendency to create possible alternatives to live events that have already occurred. The silver medalists tended to think about what could have been and lament not capturing the gold medal. For instance, in the 1912 Olympic games Abel Kiviat entered the Stockholm Olympics as the favorite to win the 1,500-meter race. In fact, he held the world record for the event. He led the race up until the last eight meters when he was passed by Britain’s Arnold Jackson. Decades after the race he would wake up in the middle of the night asking himself how he could have lost. The obvious alternative to winning a silver medal is winning a gold medal which is a much better outcome. However, many bronze medalists see their alternate reality as not winning a medal at all. Instead of wishing that they had finished with a silver medal (or even a gold) they seem to view their most likely alternate reality as finishing without a medal at all.
Investors have a very similar mentality when it comes to investing. In a study published in 2019, researchers found that investors are more likely to repurchase stocks that they had previously sold for a gain rather than stocks that they had sold for a loss. They were also more likely to repurchase stocks that had lost value following a prior sale. All these behaviors are consistent with counterfactual thinking. For instance, an investor who has previously sold a stock for a gain is more likely than other investors to repurchase the stock later. Another example might be an investor who purchases a stock at $80 that they had previously sold for $100. By purchasing the stock, the investor affirms that they were able to make an appropriate investment decision relative to a prior decision. According to Terrance Odean, a professor of finance at the University of California’s Haas School of Business and a co-author of the study, investors may choose what to buy and sell so that they can manage their own emotions.
This is not to say that any of the individual decisions that these investors have made are bad decisions. The reality is simply that an investor’s emotions can play a significant role in their decision-making process. This presents dangers as the investor may begin to confuse facts with emotions. Working with a financial professional can help investors manage those emotions. Instead of wondering what might have been or investing as if other events had transpired, a financial professional can help make decisions based on reality.
Medvec, V. H., Madey, S. F., & Gilovich, T. (1995). When less is more: Counterfactual thinking and satisfaction among Olympic medalists. Journal of Personality and Social Psychology, 69(4), 603–610. https://doi.org/10.1037/0022-35220.127.116.113