Blog - Investing Notes

November 2, 2006 - How Investors Do (or Don't) Take Advice

How do typical investors/traders process advice from others? Are they overconfidently dismissive, or underconfidently trading on the latest guru pronouncement? In their February 2006 paper entitled "Effects of Task Difficulty on Use of Advice", Francesca Gino and Don Moore perform two controlled experiments to examine the tendencies of people to reject or accept advice depending on the complexity of the associated task. In one experiment, the 61 participants (mostly university students) must seek advice, and in the other they have the option of seeking advice. Since the advice came from other participants who were generally no better informed, the best strategy for each participant was to reduce noise by averaging own opinion and advisor's opinion. Based on the results of these experiments, the authors conclude that:

• The strategy people use to process advice varies with task difficulty: they overweight advice on difficult tasks and underweight advice on easy tasks. Difficult (easy) tasks irrationally undermine (amplify) confidence in self and amplify (undermine) confidence in others.
• This finding holds when people passively receive advice and when they actively seek it. If anything, they pay more attention to advice they actively seek.
• There are no differences in advice-taking behavior due to gender.

The authors note that other research indicates that people are generally more receptive to advice from: (1) experts; (2) advisors who are older, better educated or more experienced; and, (3) advisors who project confidence. (Note in our blog entry of 4/18/06 that advisor confidence level likely relates negatively to quality of advice.) Also, people weigh advice more heavily when it is costly, regardless of quality.

For example, suppose an individual seeks advice on successful investing/trading. Much evidence (see Blog Synthesis: The Wisdom of Analysts, Experts and Gurus) indicates that consistently achieving excess investment returns is very difficult. This individual is therefore likely to overweight investing advice, regardless of its value. By overweighting this advice, the individual investor will tend to sacrifice returns by:

(1) Overvaluing, and consequently overpaying for, investment management services; and/or,

(2) Trading too much in overreaction to confident pronouncements of questionable accuracy from experts.

In summary, the difficulty of successful investing/trading probably makes many investors/traders underestimate their own knowledge/abilities and overestimate the knowledge/abilities of advisors.

For related research, see Blog Synthesis: Individual Investing for perspectives on consumers of advice and Blog Synthesis: The Wisdom of Analysts, Experts and Gurus for perspectives on producers of advice.