Representativeness

Representativeness is one of the mental shortcuts our brain can activate when faced with the need to make complex decisions. Through these shortcuts, our brain applies real strategies that allow it to save time and energy and make the decision-making process more efficient. But are we really more efficient? As we've already seen, often we're not.

The representativeness trap occurs whenever we rely on stereotypes and familiar patterns instead of looking at all the elements that can tell us something about the actual probability that an event might occur.

A situation or scenario can seem more likely to us just because it's more frequent or more represented in our personal experience. However, this spontaneous and non-rational attitude can lead us to ignore objective and statistically observable data – putting us at risk of making mistakes in both everyday life and financial matters.

Example 1

A bond issued by a company you're interested in has paid fairly high coupons over the last two years. The company is growing rapidly and is making significant investments in technology. You're sure it will continue to earn excellent profits, just as it has in the past, so you're considering buying one of its bonds to invest your savings in a security that will guarantee great returns with little risk. Are you sure that's the best choice?

Profitability today does not guarantee profitability tomorrow. It's a mistake to assume that just because a security has performed well in the past, it will continue to do so in the future. Furthermore, it's worth remembering that in general, the higher the level of risk associated with an investment, the higher the expected return. So, if you're looking for low-risk investments, this bond may not be the right one for you.

Example 2

In your family, savings have always been invested in government bonds. A colleague and your best friend have also bought government bonds because they believe it's a safe investment with a good return compared to other options. If everyone is buying government bonds, that must mean they're a good investment for you too. Is that a correct conclusion?

In reality, to evaluate whether an investment is right for you, you need to carefully analyze your personal goals. Are you investing now to supplement your income when you retire? Or do you know that in two years you'll need to buy a new car and want to invest your savings only for a short period? The people you talk to might not have the same needs as you. When in doubt, it's better to get informed properly – and maybe even consult an expert.

Watch our video to understand how the representativeness trap works.

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