Image Credit: Christophe Vorlet
By Jason Zweig | July 7, 2017 8:22 am ET
When, after more than eight years of gains, the stock market finally falls instead, your portfolio won’t be glowing green anymore. It will turn red.
That might seem trivial and obvious. Showing losses in red ink (or pixels) and gains in green is just an arbitrary convention. It’s the size, not the color, of your changes in wealth that should matter. But new research shows that color is another of the many intangible forces that can have a powerful influence on investors’ behavior.
In a series of experiments, finance scholars William Bazley and Henrik Cronqvist of the University of Miami, along with marketing professor Milica Mormann of Southern Methodist University, have found that seeing red has a drastic effect on how people view investments.
The researchers offered basic choices like these: Would you rather have a 70% chance of winning $2 and a 30% chance of losing $1.50, or a 70% chance of winning $4 and a 30% chance of losing $5? Merely by displaying the potential losses in red rather than black, the researchers could make people about 25% more risk averse (preferring the first gamble to the second, even though the latter has a higher expected value).
Likewise, investors viewed charts of stocks in the S&P 500 index with falling prices and predicted how the shares would perform in the next six months. Those who saw charts in red, rather than black, projected significantly lower returns.
A loss displayed in red feels hotter and more painful than a loss of the identical amount shown in black. It also alters your view of the future. “Simply seeing a stock’s price shown in red,” says Prof. Cronqvist, “can make you think it will go down and keep going down.”
He and his colleagues found one group of people who don’t turn pessimistic and risk averse when losses are shown in red: those who are colorblind.
Does this sound far-fetched? More often than any of us care to admit, investors’ behavior is shaped by what Richard Thaler, an economist at the University of Chicago Booth School of Business, calls SIFs, “supposedly irrelevant factors” rooted in mood and emotion.
How much risk you are willing to take can depend on such SIFs as how an investment is described; whether you are feeling happy, hungry, sad or angry; how sunny it is; the time of day and the time of year; whether your favorite sports team won or lost; whether you recently saw news of a tragedy, and so on.
These are all what psychologists call “unconscious biases” — forces that sway your decisions even though you may not be aware of them.
Color is in the same family of insidious influences.
Red stands for anger and danger, stoplights and stop signs, hot stoves, firetrucks, warning lights and panic buttons. We have red alerts, red flags and red devils. Imagine how you would react if you walked outside and saw the green grass turn suddenly scarlet.
Red isn’t always negative, of course. It’s also the color of love and warmth, roses, strawberries and other nice things. But, at least in the U.S., red generally conveys risk just as green evokes safety. Americans have used “in the red” to signify financial losses since at least the 1920s, says etymologist Barry Popik.
Now consider that the websites and apps of many U.S. brokerages and investment firms show losses in hot red (and gains in bright green).
“There’s excitement that goes with that, a little bit of Las Vegas,” says Daniel Egan, director of behavioral finance and investments at Betterment, the New York-based “robo adviser” or automated investing firm. Showing gains and losses in bright colors may make customers more inclined to trade, he says.
“We know that people overreact to their returns over short periods of time,” says Mr. Egan. “Color can reinforce that reaction and double down on the emotion.”
As a result, he says, Betterment recently overhauled its website and apps so that a muted red shows up only when investors are falling short of their long-term goals. Short-term price changes aren’t color-coded.
It might feel good nowadays to look at your accounts online and see nothing but green. That will change when the stock market starts going down. Looking at your losses then, if they are displayed in red, will make them burn like fire.
Investing apps and websites don’t offer the option to view portfolios in black and white. Maybe they should.
Source: The Wall Street Journal, http://on.wsj.com/2sNX68X
Related WSJ podcast:
For further reading:
Definitions of BEAR MARKET, BEHAVIORAL FINANCE, LOSE, and PANIC in The Devil’s Financial Dictionary
Chapter Seven, “Fear,” in Your Money and Your Brain
Research by Andrew J. Elliot and colleagues on the psychological and physiological effects of seeing red
Richard H. Thaler, Misbehaving: The Making of Behavioral Economics
William J. Bazley et al., “In the Red: The Effects of Color on Investment Behavior”
When the Stock Market Plunges…Will You Be Brave or Will You Cave?
Behavioral Finance: What Can Investors Learn From Their Mistakes?