How often is that you chose someone for a particular task just because he is nice and end up making a bad choice? This is the phenomenon of Halo effect where one attribute of a person overshadows the other attributes and influences the decisions we take. The attribute niceness of your partner has overshadowed the other essential attributes like competence and intelligence.
What is the Halo Effect?
Halo effect is a human cognitive tendency to get bedazzled with only one or some features of a person, product or company so much so that your every decision tends to get affected by those few characteristics. It is a positive attribute of that entity that influences you into believing that the rest of it shall be attuned to the same attribute.
A very common example of this effect is when we assume that a physically appealing person will also be kind, intelligent and a decent human being. However, that might not always be true. Or, if you buy a certain brand’s toothpaste and that brand has now ventured into footwear, your assumption of the product being as good is the outcome of the halo effect.
Similarly, when making investment decisions too, the halo effect plays a significant role at times.
For example, assume that you hold a mutual fund scheme of a company which has provided you with healthy returns and the same company launches an NFO for a new sectoral fund which focuses on the infrastructure sector. Now, even though the sector and the risk associated with it don’t agree with your financial plan, you may still go ahead and invest in it because of the halo effect this company has had on you.
What causes it?
Humans have a tendency to want quicker decisions and having a favourable characteristic hastens the decision. We all have judgements and pre-conceived notions about situations and people, and hence we look for reasons to affirm these judgements even if the attributes we are judging are unrelated to each other.
For example, if you invest in stocks and a particular company’s stock has consistently risen since long giving you considerable earnings; does not necessarily mean that a mutual fund scheme partly investing in this company may do necessarily well. For all you know, it might be mid-cap equity fund whereas you are looking for a large-cap fund scheme. Hence, halo effect has the capability of transforming your mind to look at only what you want to see. Because you wanted to speed up the decision, you’d probably think this company is a known one but at the end of it, this decision doesn’t equate with your financial goals at all.
Where can you possibly face it?
Below are few of the many ways in which the halo effect seeps into your investment decisions-
Hidden motives- A distributor, for example, might refer a brand’s financial products to you because he is fetching higher margins from that respective brand. Even though the products might not be a bad influence, it is possible that they do not fit into your requirements.
Media-induced- In this digital age, we consume online content at a fast rate and brands are very much aware of this. Through predictive modelling, your social media might and must be full of alternate product suggestions from the brands you previously bought from. For example, if you have bought a term insurance plan from company A, your social media feed might be telling you that A’s newly launched ULIP is a wonderful product too. Here, media is trying to create a brand halo effect reminding you of your earlier decision and urging you to reproduce it.
How to keep halo out of your investments?
Investors often fall into the trap of halo effect. They tend to take decisions solely based on parameters like PE ratio, bran, past performance etc. which dominate the other factors. The future performance of a stock depends on various other crucial factors like recent acquisitions, corporate governance, competitive advantage, fair valuation etc. A comprehensive and exhaustive analysis of all the parameters is required to make the right investments at the right price. You must follow some rules to avoid halo effect playing on your mind:
- Do your own research to identify right investment opportunity, fund managers, investment process, portfolio valuation etc.
- Compare products of similar nature from different companies and evaluate the difference
- Focus on the end goal or objective that you aim to achieve and that really matter and not the other niceties which are good to have but not necessary to have
- Consult a SEBI registered RIA like TrueMind Capital Services who provide you with absolutely unbiased financial advice and also suggests the products that are right fit for you investment objective and not just the products that are popular
Watch the below video for understanding The Halo effect.