Investors beware - we are hard-wired to be wary of red

Alarms, sirens, stop signs – the colour red has long been associated with danger and the need for vigilance, and this is also true of the financial world. If you lose money you’re “in the red”. A red flag denotes a warning signal. Online brokerages typically display losses in red and gains in green. Should this matter to investors? No. Does it matter? Yes.

New research shows that when we see red we get the jitters, potentially resulting in us throwing carefully-made investment plans out the window. That's according to In the Red: The Effects of Color on Investment Behaviour, a new study co-authored by Henrik Cronqvist from the University of Miami.

Earlier Cronqvist research shows that all kinds of factors – for example, our genes and the economic environment in which we grew up – influence our financial decision-making. His latest work adds to the mountain of research showing that when it comes to money matters we don’t always weigh things up in a rational, Spock-like manner.

In one experiment participants were presented with a series of lottery choices. For example, would you prefer a lottery with an 80 per cent chance of gaining $2 and a 20 per cent chance of losing $1.50, or a lottery with an 80 per cent chance of gaining $4 and a 20 per cent chance of losing $5? All participants were presented with the same choices apart from one minor tweak – potential losses were highlighted in red to one group of participants and in black to others.

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Importantly, people became roughly 25 per cent more risk-averse when the colour red was used. In a second experiment participants were shown a series of price charts featuring declining stocks and asked to estimate how the stock would perform – specifically, the most-likely scenario, the best-case scenario and the worst-case scenario – over the following six months.

Again, investors presented with red as opposed to black charts were “significantly” less optimistic about future returns. Their best-case estimates were much lower; their worst-case estimates were more dire; the most-likely scenario, they said, was that the stocks in question would continue to fall by almost 4 per cent per month, compared to a neutral outlook reported by those presented with black stock charts.

Overall, simply using the colour red reduced investors’ propensity to buy stocks by about 20 per cent, the study found.

Spooked

Could it be a fluke? Is it possible the results are distorted by some unaccounted factor? Unlikely. The pattern vanished when alternative colours were used.

Additionally, not everyone was spooked by the colour red – no increase in risk aversion was found among colour blind investors.

Furthermore, the researchers conducted the same tests in China where the colour red is associated with good fortune and is used to represent positive rather than negative financial returns. Consequently, the "seeing red" effect was "significantly muted". In other words, the results are pretty clear-cut. Unless you're colour blind or Chinese you're likely to find that you get spooked by the colour red. It skews "perceptions of financial information and financial judgments", making people "more risk-averse and more pessimistic about the quality of financial assets and their future values".

Culture plays a part in the “red-danger association”, as attested by the more “muted” Chinese results, although evolutionary forces also appear to be at work.

For example, the authors note research showing that when monkeys were given the opportunity to steal food from two human experimenters, they “systematically avoided the experimenter wearing red”.

Why? Red is the colour of “objectively dangerous phenomena” that people encountered in early societies, such as blood or fire. A red face, the study notes, “signals anger and aggressiveness, and may serve as a testosterone-based signal of dominance”. In other words we are hard-wired to be wary of the colour red, and this has real-world investment implications. Anyone who has ever checked their portfolio online knows that during a market downturn brokerage screens resemble a sea of red.

Blood in the streets

Although it’s generally a good idea to buy when there’s blood in the streets, Prof Cronqvist says investors may be less likely to buy stocks when prices fall because the media and online trading platforms are dominated by the colour red.

Brokerages and investment firms should consider tweaking their trading platforms to address investors’ “hard-wired biases”. Indeed, US robo-adviser Betterment has already take note, recently changing its website and apps so that market price changes are not colour-coded.

Colour "can drive investor behaviour", said Dan Egan, director of behavioural finance and investments at Betterment.

Fellow behavioural finance expert Dr Greg Davies agreed, tweeting that he was "massively unsurprised" by the research findings.

This lack of surprise reflects the fact there is a mountain of research showing investors are influenced by "supposedly irrelevant factors", or Sifs to use the term coined by behavioural economist and Nudge author Richard Thaler.

Investors' moods are shaped by all kinds of Sifs. For example, one study, Sports Sentiment and Stock Returns, found that national stock markets are more likely to decline in the aftermath of disappointing football results. This effect is more pronounced in the World Cup than the European Championships, and following especially important games, particularly in football-mad countries like Brazil and Italy. A similar effect is evident following losses in other sports such as cricket, rugby and basketball. A multitude of other Sifs have been identified.

Studies show investors who have experienced low-probability events such as earthquakes are more likely to believe a future market crash is likely.

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Men are much more likely to take up loan offers when the loan brochure contains a picture of an attractive woman (according to one South African study, the increase in take-up was equivalent to dropping the interest rate by 4.5 per cent).

Automatically enrolling employees into company pension schemes has a much bigger impact on retirement savings than offering employees tax subsidies.

Research shows that when we’re sad we’re much more likely to make poor financial decisions, plumping for short-term instant gratification above sounder long-term options.

“Contrary to the predictions of traditional theory, Sifs matter”, says Richard Thaler. Cronqvist’s research bears out Thaler’s point. “Biologically ingrained evaluation processes in the human visual system” mean that when we see red, we see danger. This danger, whether real or imagined, makes us more inclined to flee – a hard-wired response which may have served our ancestors but which may prove costly for investors.