A new study just published pointed to some important clues in understanding financial risk-taking. Avni Shah, an assistant professor of marketing at the University of Toronto Scarborough who conducted the research with Xinlong Li of Singapore’s Nanyang Technological University. Economic research suggests that people regularly uncouple from their previous time selves when they move into new time periods, such as the conclusion of a work week, month, or year. This further disconnection breeds an air of absolute superiority in their investing choices.
The researchers also delved into data from Prosper, a leading P2P lending platform in the U.S. To do this, they examined over five million investment choices made from November 2005 to mid-October 2008. As their research has shown, these temporal landmarks can powerfully affect financial decisions and risk perceptions by creditors.
The Role of Temporal Landmarks
Shah and Li’s investigation uncovers a key finding. They concluded that definite temporal markers, such as the completion of a week or month, motivate individuals to adopt a longer-term and more positive perspective on financial risks. This effect happens because people feel that these changes are a chance to make a “clean slate” or “new beginning.”
“New periods serve to disconnect individuals from their past selves and offer a ‘fresh start,’” – Avni Shah and Xinlong Li
Unfortunately, this sense of renewal comes with an egging-on impulse to self-sabotage with money. Taking a deeper look into the data showed that bids submitted on Fridays had the largest maximum interest rates of any day of the week. In a similar fashion, bids placed on Wednesdays and Thursdays prior to observed public holidays displayed heightened risk-taking tendencies.
Prof. Shah emphasizes that “the end of a work week, end of month, and end of a year are points in time that seem to have a clear impact on the financial choices and financial risk that we take.”
The research has demonstrated that in the experience of consumers, optimism does not ultimately translate into positive financial results. Loans made at the close of these periods produced much lower returns compared to loans made at other times in the cycle.
Implications of Investment Behavior
The potential impact of these results is significant for individual investors and economic corporations alike. This same optimism was the focus of the researchers’ second finding, a black swan predictor — that optimism associated with temporal landmarks does not lead to improved investment outcomes.
Prof. Shah noted, “Our results suggest that end-of-period landmarks may be important as well, affecting even consequential risk decisions.” This speaks to a greater importance for lenders in being conscious of their emotional and psychological disposition when determining investment priorities.
Moreover, the study underscores a unique aspect of peer-to-peer lending: loans do not yield immediate returns. “Individuals can’t take risks in ways that will pay off and balance their budget in the short term,” Prof. Shah explained. This mismatch between risk perception and actual monetary impact leads to troubling questions about investor behavior and deliberation processes.
Optimism vs. Reality
The results further illustrate how social constructions of time can shape the bargaining space for decision makers. Unfortunately, these constructs act as canaries in the coal mine cues that can trigger us to make poor financial decisions. Specifically, of the dates analyzed, December 31 had the most max interest rates. It beats every other work week or month final day.
“Our research suggests that these socially constructed end-of-period temporal landmarks play an important role and serve as a cue in our decision-making,” – Prof. Avni Shah
Knowing how psychological factors shape financial behavior is key to facilitating change. This is particularly so in contexts where individual consumer decisions are of extreme importance. Investors can get an upper hand by being aware of these tendencies and taking a more tempered view towards their investment strategy.