by Kit O'Connell

Past Performance Not an Indication of Future Performance?

A wizard measuring the stars

It’s that time of year again: Late January, when it’s finally time to stop wishing everyone a Happy New Year, when the post-holiday buzz has worn off, and we begin to see signs of what the year has in store. It’s also just about time for some bored financial analysts to remind us of the Super Bowl Indicator, an economic equivalent of Punxatawney Phil and his famous shadow.

In the four decades since the American Football Conference and the National Football conference have merged, the Super Bowl Indicator has correctly forecast the new year’s economic climate thirty-three times. That’s an 80% accuracy rate, which is more than we can say for this season’s championship quarterbacks. According to the Super Bowl Indicator, the economy will improve if an NFC team wins (San Francisco 49ers or New York Giants), or deteriorate if an AFC team wins (New England Patriots or Baltimore Ravens).

Last year’s football economics roundup from Slate demonstrates that companies who advertise during the Super Bowl can reliably expect a return on their ad dollars, and it makes logical sense that putting your product in front of hundreds of millions of Americans might generate a few extra sales. But are you really inclined to believe that we’re in for more hard times if Tom Brady goes home with another ring? And if the Super Bowl Indicator is such a silly idea, why does it come up every year?

The answer shouldn’t surprise you: Your silly brain likes patterns.

Apophenia: Recognizing Patterns That Aren’t There

The general tendency toward perception of patterns where none exist is called apophenia. In her detailed survey of the phenomenon, Sarah L Hubscher quotes another writer, J. Cohen: “nothing is so alien to the human mind as the idea of randomness.” We imagine that a random set of information will have no recurring elements at all. While this search for meaning has led to great discovery, it can also be easily misled. According to a study uncovered by Hubscher, our memories seem to be a key factor—when shown strings of numbers and asked to judge how random they were, subjects judged strings which were easily memorized as less random compared to strings artificially selected for their difficulty.

The good news is that apophenia probably doesn’t sneak into your financial decision making as much as some of the other tricks your brain might play. Still, it’s important to acknowledge that some things really are random, even if you think you spot a pattern. So, if the Giants win this Sunday and win again in Indianapolis, don’t go making risky investments because the market should do well for the next year.

Confirmation Bias: When Everything Seems to Line Up

Our tendency to rely on memory is further complicated by confirmation bias: once we believe we see a pattern, it becomes even harder to disprove. We pay more attention to data which confirm our initial hypothesis, and we tend to ignore or discount that which denies it.

Similarly, it becomes easier to recall supporting events when we think back into our past, according to philosopher Robert Todd Caroll’s Skeptic’s Dictionary entry on the subject. Over time, our belief in the existence of this pattern becomes unshakable, even if it was founded on nothing but a string of coincidences.

Confirmation bias manifests in many ways, from your lucky jersey to your insistence that your team will keep winning as long as you don’t shave. You know that Eli Manning always throws a touchdown when you get up for a drink, but how many points have the Giants scored while you were checking your phone, or actually watching the game?

If you extend this superstition into finance, you might invest in a company whose founder has the same name as your all-time favorite running back: It’s a comforting coincidence, but you’ll be disappointed when the correlation doesn’t add up, or pay off.

The Clustering Illusion

When we see a random event or coincidence occur again and again, we tend to look for clusters or streaks. This clustering illusion tells us, for example, that if a flipped coin comes up heads four times in a row, there must be something at work beyond simple chaos. It’s closely related to the gambler’s fallacy, which stems yet again from a misunderstanding of probability and randomness.

Every time the coin is flipped, the chance for it to land on heads or tails is the same; the past has no effect on future outcomes. Yet the gambler becomes convinced he is on a winning streak, or that his poor luck must change. In his series on Behavioral Finance, Albert Phung cautions against this illusion in investing: Just because a stock has gone up in many subsequent trading sessions does not mean the trend will sustain itself, nor that a failing investment is likely to suddenly turn around. Just ask Tim Tebow.

Being aware of these behaviors helps, but it’s easy to further delude ourselves into thinking we’ve already taken them into account. The scientific method demands researchers seek out others to test their results. Likewise, investors should seek second opinions from knowledgeable financial advisers. We should focus our savings in sound, long-term investments rather than chasing that elusive shortcut to riches.

Knock on Wood

The more you learn about your investments, the less your choices will feel like gambles. Intuition may be powerful, but it’s important to check that sense and make sure it isn’t your mind looking for patterns in a random set.

And, since the Super Bowl Indicator can’t possibly be real, I’ll be making snacks from my native Maryland for the rest of the weekend. Just so everyone knows, the Ravens will win as long as I buy a new can of Old Bay.