1) Imagine you’ve inherited $100,000. In which portfolio are you more apt to invest the money?
A) A portfolio of moderate-risk stocks
B) A portfolio of high-risk stocks
C) A portfolio of Treasury bills
D) A portfolio of municipal bonds
2) Now imagine you’ve inherited $100,000, but you were told that the money was previously invested in the high-risk portfolio of stocks. In which portfolio are you more apt to invest the money?
A) A portfolio of moderate-risk stocks
B) A portfolio of high-risk stocks
C) A portfolio of Treasury bills
D) A portfolio of municipal bonds
3) Now imagine you’ve inherited $100,000, but you were told that the money was previously invested in the portfolio of Treasury bills. In which portfolio are you more apt to invest the money?
A) A portfolio of moderate-risk stocks
B) A portfolio of high-risk stocks
C) A portfolio of Treasury bills
D) A portfolio of municipal bonds
Different participants were told that the money was formerly invested in the different portfolio choices. The form of the investment at the time of the endowment heavily influenced the portfolio choices made by the subjects. The high-risk portfolio choice was more popular when the inheritance was formerly invested in the high-risk portfolio. The same was true for Treasury bills and so on.
Clearly, the expected risk and return of a portfolio consisting of Treasury bills and one comprised of high-risk stocks are very different, yet subjects were more influenced by status quo than by their personal risk-and-return objectives. You see, people are often willing to put $100,000 from a year-end bonus in the stock market, but choose to invest a $100,000 inheritance in a certificate of deposit. Why? You guessed it! The say, “I can’t take the risk with that money; my parents worked very hard for it!”
Interestingly, the status quo bias also increased as the number of investment options increased. That is, the more complicated the decision that was needed became, the more likely the subject was to choose to do nothing. In the real world, investors face the choice of investing in tens of thousands of stocks, bonds, and mutual funds. The choices are overwhelming! As a result, they often choose to avoid making a change. The issue becomes magnified when the investments have lost money, as selling a loser triggers regret and the pain of losing the endowment.
Many investors let their emotions or other external factors influence their investing decisions, which can lead to unintended results. For example, even though the $100,000 mentioned above may have been accumulated through investments in Treasury Bills, if you were looking to achieve “above average returns,” the likelihood of achieving that goal through continuing to invest in Treasury Bills would be considered unlikely. Therefore, if you were to let external factors such as these affect your decision making, it could have a massive impact on your overall return.
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