How Understanding False Memories make us Better Investors

false memory upside

11 May How Understanding False Memories make us Better Investors

In 2001, psychologists Sharon Hannigan and Mark Reinitz conducted a classic experiment to study the effect of memory ‘illusions’. They first showed participants a series of pictures, amongst them ‘effect’ photos. An ‘effect’ is one that depicts an outcome. For example, oranges scattered on a supermarket floor or a lady sprawled after suffering a fall.


1. Cause (banana peel) and 2. Effect (fall)

After variable intervals ranging from 15 minutes to 48 hours, they showed the same participants another series of pictures and asked them to identify which ones they have seen before. Within this series Hannigan and Reinitz inserted ’cause’ pictures.

Cause pictures are ones that contain a probable cause of an outcome picture that they have seen before. In this case it could be someone reaching for an orange from the bottom of the stack or a banana skin littered on the floor.

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They discovered that a significant number of participants indicated that they have seen the cause picture (pic 1) when they in fact they have not. In other words, someone who has seen the lady taking a fall (pic 2) would without hesitation identify a banana skin picture as one that they have seen.

This phenomenon became known as the Casual Inference Error. Simply put, if information given to the brain is incomplete, the brain will do whatever it takes to assemble such a story – to the extent of generating False Memories.

Certainty and meaning

As human beings, certainty and meaning are important to us. The need to understand dominates our lives. When we are faced with an uncertainty or an unknown we become uncomfortable. Arising from this discomfort we strive to find reasons to explain what we have just seen, heard or experienced.

On a large scale, it is this need for knowledge that has ensured the survival of the human race. By constantly striving to explain what is happening around us, we have managed to make progress throughout history and learn from our past mistakes. When someone falls sick we seek to find the cause and rectify it. When an earthquake happens we study and determine how some areas are particular prone and build stronger buildings over the faults. The need for reason has made us stronger as a whole.

On a micro scale we are also constantly asking why and assigning reasons in our daily lives. When we pass by a chicken rice stall with a snaking queue we reason that the food must be amazing, when someone drives a Ferrari we and associate him with being rich, when our boss comes to work in a foul mood we like to think that they have had a bad day at home.

We do not know if the chicken rice is really yummy, or if the driver is indeed wealthy, or if our boss did quarrel with her husband or his wife. The real reason behind the cause is unimportant and we seldom go out of our way to verify it. Unless we have intentions to eat lunch, chances are we will not join the chicken rice queue just to find out. We never ever ask a Ferrari driving stranger if he is rich or our boss if he or she is having problems at home.

Like subjects in the experiment, we are always given incomplete information in our lives. We reason to ourselves subconsciously hundreds and thousands of time every single day. And we are doing every day is exactly what the experiment is made to demonstrate – we see an effect, and we assign a cause.

The very act in assigning a reason brings about closure. It brings about comfort. And closure and comfort is more important to us than anything else. What Hannigan and Reinitz have just demonstrated is the length the mind will go just to seek comfort. We will do anything. Including manufacturing false memories, just to arrive in that comfort zone.

The Cause and Effect of News.

Here are some headlines off the internet.

Dow falls 2% due to tapering woes. Gold regains shine as dollar slips. Natural Gas prices down slightly due to moderating weather. Property prices fall with cooling measures in place.

They all have in common one theme. There is a cause and an effect. Or shall I say, an effect and a cause. Dow has fallen (effect), and it is due to possible Fed tapering (cause assigned). Property prices have moderated (effect), and that is because of cooling measures (cause assigned).

By assigning a cause, journalists and news makers help us to make sense of the world. They help us to seek closure. Rather than spend time trying to figure it out, we now know why the Dow or the property market has fallen.

But take a moment to think about it. Is it the real cause? Or is it just a convenient cause? Could the ’cause’ even be ‘false memories’ generated? Are we better off ignoring them?

Investing is decision making

As investors our role is simply to make decisions. In order to make the correct decisions an understanding of our thought processes is crucial. By understanding how we think and what failings we are prone to, we end up making better decisions. And better decisions make for better investors!



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