What is the Narrative Fallacy?
One of the limits to our ability to evaluate information objectively is what’s called the narrative fallacy. In other words, we love stories, and we let our preference for a good story cloud that facts and our ability to make rational decisions. It means that we may be drawn towards a less desirable outcome simply because it has a better story. This is an important concept in behavioral finance.
Why Do We Love Narratives?
We are all hard-wired to love stories. Why do we love stories? Typically, stories have emotional content, which appeals to our subconscious or reflexive reasoning. Because stories have that emotional component, they’re very easy to remember.
In fact, when teachers are lecturing to students, they often use stories. They do this because they know when they show up to class the next day and ask students what they remember, they’re more likely to remember the story than any of the formal information they were taught.
Issues with the Narrative Fallacy
The problem with stories is that they govern the way we think; we tend to prefer stories. What’s interesting in the financial markets and as investors is that we will often abandon evidence in favor of a good story. It is one of the reasons why people actually shy away from value investing, which forces investors to look at stocks that typically do not have good stories. In fact, they often have horrible stories. The most admired stocks have the greatest stories, but they also have the highest prices.
So, are you being limited in your learning by stories? Label the stories, set them to the side, and try and focus on the facts.
Thank you for reading this guide to the narrative fallacy and why it’s important to be aware of it in finance. To learn more, check out CFI’s Behavioral Finance Course.
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