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The Ostrich Effect: Burying Your Head in the Sand

September 6th, 2020 by 
PK

The Ostrich Effect refers to the human tendency to avoid negative information as it relates to personal finances. 

Although ostriches don't actually burrow body parts in the sand, humans seem to ignore negative risks to (or effects on) their money.

What is the Ostrich Effect?

The moniker "Ostrich Effect" was first coined by Dan Galai and Orly Sade in their 2006 paper The “Ostrich Effect” And The Relationship Between The Liquidity And The Yields Of Financial Assets.

They observed that Israeli T-Bills paradoxically provided a higher yield to maturity than Israeli bank deposits. Further, it wasn't explained by any common factors such as risk, taxes, or transaction costs. No, the puzzle had to have another factor - that factor the team coined the 'Ostrich Effect'.

Ostrich effect illustrated by its namesake
Oh no, is that a recession approaching?

Interestingly, the Ostrich Effect is different than willful ignorance and somewhat closer to cognitive dissonance

The Ostrich Effect requires broader knowledge of the general state of the economy or an asset class, and a subconscious desire to not check on a portfolio. The seminal study saw a curious bias towards assets that didn't even report on their risks. The lack of information seemed to fuel interest - a related bias they termed "the bliss of ignorance".

Does the Ostrich Effect Actually Exist?

You can be forgiven for asking: can we extrapolate from Israeli bond and band note investors to the entire world?

In 2009, Niklas Karlsson, George Loewenstein, and Duane Seppi tried to spot an Ostrich Effect across Swedish and American investors. Indeed, they found the same curious effect - people could "collect additional information conditional on favorable news and avoid information following neutral or bad news".

The Ostrich Effect showed up (and hid its head) - and suspiciously appeared to look like a cognitive dissonance avoidance tactic.

Arguments Against an Ostrich Effect

That's not to say every study has come to the same conclusion. Svetlana Gherzi, Daniel Egan, Neil Stewart, Emily Haisley, and Peter Ayton revisited the phenomenon in 2014  for the paper The meerkat effect: Personality and market returns affect investors’ portfolio monitoring behaviour.

They concluded that portfolio-checking increased for both large up and down days. Their data found that an investor's level of neuroticism was more predictive of how often they checked portfolio performance. They even pinned an entirely new term on the effect - they called it the meerkat effect. Unlike the mythical head-burying ostrich, a meerkat is hyper-vigilant in the face of danger.

Note that they did however see a larger increase in investor logins during positive surprises than for negative ones. Indeed, they even stated that "might be indicative of two effects, one of which masks the other: an effect on information monitoring that increases with changes in market returns in either direction and a hidden underlying ostrich effect that somewhat suppresses monitoring when returns are negative."

Is the Ostrich Effect Bad?

Sometimes the best move is actually to do nothing.

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Many behavioral biases are double edged swords.  If the Ostrich Effect exists – and it affects your behavior  – it might not be such a bad thing.

Consider that a large cause of investor under-performance is portfolio churning. If you work up your anxiety to the point that you panic sell, there's a price to pay.  Planned sales allow more flexibility in managing and avoiding fees, or maneuvering to minimize the costs of a sale.

Sometimes the best move is actually to do nothing.

Witness, for example, the long-term performance of the S&P 500. Over a long period, the index and dividends have provided a tremendous return. However, there are many periods when the S&P 500 was down significantly. If you sold then, you wouldn't have been able to ride the wave when the tide returned!

So, maybe the ostrich effect is a good thing for many asset classes.

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