Judgmental Heuristics

By TAN Kee Wee
(MediaCorp 938LIVE’s Money Talks, Friday, 28 September 2012, 7.55 am, and Saturday, 29 September 8.35 am)

Other than the best places to eat, we love to hear juicy stories about other people’s sex lives. Whether it is sex-for-grades or sex-for-business, curiosity drives us to search for photos of what the parties involved look like.

Having studied their facial features, usually with great satisfaction, we quickly and very unscientifically form our intuitive judgment of them.

Never mind if it is not the truth. Worse, when we next meet someone with the same facial features, we assume that their personality traits are the same.

In Behavioral Economics, this shortcut behavior is known as judgmental heuristics or judgmental shortcuts. This behavior happens because there is too much information for us to process.

We respond to the information overload by looking at only a small part of the whole picture. Basically, we like to simplify things. We like to draw analogies and see identical situations where in fact there are important differences

Unfortunately, this behavior applies also to our investment decisions.

Four years ago this month, the financial world went into a tailspin after Lehman Brothers collapsed. In early 2009, the global economy looked grim. Singapore property prices had already slipped some 35 percent. Potential buyers were told not to buy because prices would go down further.

This bearish view was easily accepted because the preceding experience of property investors supported it. Because in 1997, a Bishan HDB apartment was sold for the record price of S$760,000. After that sale, the market sank and remained there for many years.

As it turned out, the bearish advice of early 2009 was wrong. Singapore property prices climbed soon after and went on to rise towards heaven. Many say the strong rebound was due to the massive money printing by the US Fed.

Two weeks ago, an HDB apartment in Queenstown was sold for the record price of S$1 million. There must be many reasons why the buyer paid that high price.

One possible reason could be the buyer’s confidence that the US Fed would print more money again. In fact, his confidence was justified.

“Just as in 2008, prices will go up. There is little downside risk.” If the Queenstown flat buyer thinks like this, he is not alone. Many investors think likewise and have been falling over themselves buying up properties.

Of course, the bears take the opposite view. They would say that the bulls are wrong. They are demonstrating judgmental shortcuts if they think that property prices will do a repeat of 2009.

While printing more money usually leads to inflation, the data show that the impact on inflation of the US Fed’s money printing has actually weakened since 2010.

It is like drinking our first cup of coffee. It kept us awake the first time round. But once we become coffee addicts, caffeine no longer has the same impact. We could drink a cup and fall asleep immediately.

The bears would also say that the situation today is very different from that in 2008. This time round, not only is the euro in crisis, the US government has serious debt problems, and the Chinese economy is about to cave in.

By pointing out that the two situations are not the same, the bears try to avoid making judgmental shortcuts. Even so, the bears can be wrong. Because very often, judgmental shortcuts work exceptionally well.

What this means is that next year, a Queenstown HDB apartment will be sold for S$2 million. And that girl, with what the Chinese say Peach Blossom eyes? She is really good.