Social Psychologist Lee Ross ran an experiment where he took peace proposals created by Israeli negotiators and labeled them Palestinian. He then labeled Palestinian peace proposals as Israeli.
He presented them to Israeli citizens and asked them which ones they liked better.
They liked the Palestinian proposals that were labeled Israeli and disliked the Israeli proposals labeled Palestinian.
Geoffrey Cohen ran a similar experiment in the U.S. and found the following.
Democrats will endorse an extremely restrictive welfare proposal, one usually associated with Republicans, if they think it has been proposed by the Democratic Party, and Republicans will support a generous welfare policy if they think it comes from the Republican Party. Label the same proposal as coming from the other side, and you might as well be asking people to support a policy proposed by Hitler, Stalin, or Attila the Hun.
Both examples are from the book, Mistakes Were Made (But Not By Me) and they were designed to explain Naive Realism and the cognitive dissonance it creates.
But they are also two great examples of the Halo and Horns Effect, a behavioral bias that we all succumb to.
The Halo Effect happens when you like some aspect of a person you tend to like all other aspects of that person even if you barely know them or never witnessed their other attributes. You also tend to overrate their abilities.
You meet Jane at a cocktail party. Jane is personable and easy to talk to. You enjoyed your brief time with Jane. Then later on someone running a charity asks you how generous Jane is and how likely Jane will donate to their charity. You will most likely rate Jane as very generous and very likely to donate to the charity.
But how do you know this?
You know nothing about Jane’s generosity. You only really know that Jane was friendly and personable. You overrated Jane’s level of generosity because you liked her.
The opposite is the Horn Effect. You tend to underweight someone’s abilities and dislike all other aspects of a person based on one trait.
As Goeffrey Cohen pointed out our political beliefs are heavily influenced by our behavioral biases and it has unintended consequences on your portfolio.
Politics & Portfolios
From the paper Political Climate, Optimism, and Investment Decision.
In our main empirical analysis, using the Gallup data, we show that Democrats (Republicans) become more optimistic about the stock market and the overall economy when Democrats (Republicans) come to power and there is a decline in optimism when the opposite party comes to power.
Investors tend to increase their exposure to risky more volatile assets when their political party is in power and decrease their exposure when the opposite party is in power. The increased exposure to risk assets has the effect of increasing the investors’ returns over time, but not for the reason they think. The casual investor will attribute the performance to their political leader. In reality, increasing their risk exposure simply increases their odds of having higher returns in their portfolio, regardless of which political party is in power.
Former Hedge Fund manager turned newsletter publisher Whitney Tilson very publicly showed the Halo and Horn Effect in action.
Mr. Tilson spent considerable effort campaigning for Hillary Clinton during the 2016 Presidential election. After Donald Trump won the election Whitney Tilson sold more of his equity positions into the market rally.
By Wednesday morning, as stocks made a big comeback rally after a near-800-point plunge late Tuesday night in pre-market futures trading on the prospects of a Trump victory, Tilson was busy unloading shares into the rally. “I was at 60 percent cash coming into today, and I’m selling stocks today,” he told the New York Times.
To his credit, Mr. Tilson eventually recognized his error, corrected it, and publicly acknowledged it. Three very hard things to do.
How to Combat It
The Halo and Horns Effect is another mental heuristic we use to make quick decisions. It is a form of pattern recognition that often produces irrational and heavily biased decisions.
It is hard for us to tell when we are making an irrational decision based on simple heuristics and there is no easy way to counteract their effect. Especially if it is an emotional bias versus a cognitive bias.
A cognitive bias is an error made from faulty reasoning because of basic statistical, information-processing, or memory errors. Correcting our reasoning errors corrects our judgment. Usually.
The Halo and Horns Effect is an emotional bias based primarily on feelings and this is hard to counteract. Better statistical modeling is not going to change how we feel inside.
But the first step to reducing both cognitive and emotional biases is to slow down our thinking. This comes from building portfolio management systems that prevent us from making rash decisions.
If you operate within a team, it is helpful to have someone play devil’s advocate. Someone that can argue the opposite position in an effective and accurate method. Or help you clarify your thinking,
If you’re by yourself then you need to heed Charlie Munger’s advice.
I never allow myself to have an opinion on anything that I don’t know the other side’s argument better than they do.
And from Farnam Street.
You have to do the reading. You have to talk to competent people and understand their arguments. You have to think about the key variables and how they interact over time. You have to listen and chase down arguments that run counter to your views. You have to think about how you might be fooling yourself. You have to see the issue from multiple perspectives. You have to think. You need to become your most intelligent critic and have the intellectual honesty to kill some of your best-loved ideas.
By taking the time to slow down, consider alternative perspectives, and critically evaluate our biases, we can become better decision-makers.