A reduction in cognitive skills adversely impacts a person’s ability to keep stock market volatility in perspective. Rather than thinking about stock market returns as occurring mostly within a range of probable outcomes, those with low cognitive skills view stock market returns as being uncertain.
The finding is based on the analysis of answers to a question included in the Health and Retirement Study (HRS), which is a national study of adults age 50 or older in the U.S. The question asked individuals to estimate the chance that mutual fund shares invested in blue-chip stocks—such as those in the Dow Jones industrial average—will be worth more a year from now than they are today. Possible answers could either be a single number between zero (absolutely no chance), and 100 (absolutely going to happen) or “don’t know.”
The average response given during the biannual periods occurring from 2002 to 2010 was 46.5%. The most common answer was 50%. Both are below the actual performance of the Dow, which rose in 68% of all calendar years from the end of the World War II era to the end of the study period. Slightly more than 18% of respondents gave “I don’t know” as an answer. Respondents with higher cognitive skills were more likely to give an answer.
Nearly 40% of respondents listed a subjective probability of 0%, 50% or 100%. A challenge with giving 50% as an answer is that it can either mean an even chance of one outcome or another, or it can be an expression of uncertainty. In response to a follow-up question asking respondents to clarify their 50% probability answer, nearly two-thirds (64%) of respondents replied “no one can know.” The study’s authors described such responses as being “significantly less common for respondents with high cognitive skills.”
The survey results further showed “a strong relationship between subjective return probabilities and stock holdings for individuals with higher cognitive skills.” The relationship of stock ownership for those with low cognitive skills is weaker. This implies that those who tend to view stock returns “in more fuzzy and ambiguous terms” are less likely to invest in stocks.
Source: “Does Everyone Use Probabilities? The Role of Cognitive Skills,” Johannes Binswanger and Martin Salm, forthcoming, European Economic Review.
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John Sebelius from ME posted over 9 years ago:
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