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By Jason Stipp | 10-07-2013 10:00 AM

Don't Get Stuck in Stock Stereotypes

Investors too often use an atypical success story, such as Google, instead of the more common unsuccessful venture, when seeking a basis of comparison for a new investment idea.

Jason Stipp: I'm Jason Stipp for Morningstar.

We've discussed a lot of the behavioral pitfalls that investors can fall into as they're making their investment selections, but one you might not have heard about is how stereotyping can impact your investment decisions.

Here to talk about that and some ways we can think about overcoming stereotyping is Raife Giovinazzo. He's director of research at Fuller & Thaler and also a manager at Allianz Global Investors' U.S. Large Cap Behavioral Advantage Fund.

Thanks for joining me, Raife.

Raife Giovinazzo: Thanks for having me.

Stipp: Stereotyping is something that we've heard about in a social sense, but you say it can also impact our investment decisions. You've read some research specifically about how stereotyping impacts us psychologically.

Giovinazzo: Yes. So, stereotyping is making decisions based upon the similarity to some stereotype or archetype of an event, rather than the underlying fundamentals or the true frequency.

A classic psychological experiment examined people's estimated frequencies in likelihood that a person, given a very vague description, was a particular graduate major.

First, there was a question to the students about how frequent are these various majors? And they match the actual frequency, which is humanities are a lot more common than engineering, for example.

Second, they said given this description of a high intelligence but not very creative person who likes tidiness and is neat and orderly--sort of the generic stereotype of what you'd think for an engineering student--they said, how similar is this to your image of this person, your stereotype of this person, and they all said, oh, it sounds like an engineering student.

The third group was asked, what do you think they are? And overwhelmingly people said, oh, it's an engineering student. The answers were 97% correlated with how they rated the similarity, and they were actually negatively correlated with what they'd previously said were the frequencies of the various graduate degrees.

The problem here is, this is a very vague description that they're going off of, and they're completely reacting to the similarity, to the stereotype, as opposed to considering what is the base rate, what is the underlying frequency of this kind of an event.

So, that's the standard research and I'm happy to talk about how it applies to stocks.

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