The Crooked Path Down Memory Lane

by The Algonquin Team, Algonquin Capital

Memory is deceptive because it is colored by today’s events.

Albert Einstein

Suppose your doctor tells you that you must undergo an uncomfortable medical examination and that there are two choices available.

Option A: 8 minutes of sharp, intense pain and the procedure ends.

Option B: The same 8 minutes of intense pain as Option A, followed by an additional 16 minutes of moderate pain, concluding with some mild discomfort.

At this point, you’re probably considering switching doctors. Oddly enough, despite how ludicrous the second choice seems, it may give you a better memory of the experience.

This is not to say you are a masochist, but this was the surprising result of a study conducted by Daniel Kahneman and UofT’s Donald Redelmeier. They asked colonoscopy patients to rate the intensity of pain at one-minute intervals as well as give an overall pain rating afterwards. Their findings drew an interesting distinction between the experience and the memory of the procedure, offering evidence of a heuristic known as the peak-end rule.

The peak-end rule states that our memory formulates an opinion of an experience based on how we feel at its most intense point and at the end, remaining largely indifferent to the duration and the sum of the individual moments.

For example, Patient A goes through an 8-minute examination with a peak pain of 8 (out of 10) and in the last minute a rating of 7. Patient B experiences the same 8 minutes, and for the next 16 minutes is exposed to varying degrees of pain, finishing with a mild discomfort registering a lowly rating of 1.

When asked to rate the overall experience, Patient A gives it a 7.5 on the pain scale while Patient B gives it a much lower rating of 4.5. This despite the process lasting three times longer and the person enduring a much greater aggregate amount of discomfort.

Thankfully anaesthetics are administered for colonoscopies now, but the peak-end rule has much wider and deeper implications. In the wonderful world of investing, history is often used as a guide to gain perspective. This particular bias leads us to overemphasize market extremes and give disproportional weight to recent events. Because 2008 left an indelible mark on investors; they may find themselves overly referencing this period as well as the most current market events in their analysis.

The problem with this is that it ignores important considerations such as the passage of time, the fact that markets can spend ages at fair valuations, and changes to the macroeconomic fundamentals. Without careful analysis and thought, there is a significant risk of jumping to erroneous conclusions.

When we base investment decisions purely on gut-feel or intuition, we are relying heavily on our memory. Unfortunately, the peak-end rule and a host of other biases indicate that our memory is not ‘all that it is cracked up to be.’

 

Copyright © Algonquin Capital

Total
0
Shares
Previous Article

SIA Weekly: EM Equities Outperforming Developed Market

Next Article

Are U.S. Banks Still Cheap?

Related Posts
Subscribe to AdvisorAnalyst.com notifications
Watch. Listen. Read. Raise your average.