History Lessons Can Help Investors Respond to Inflation
In one study, seeing historical return data caused them to make tactical adjustments.
History Lessons Can Help Investors Respond to InflationFrancesco Ciccolella
Every graduating class has its own distinctive suite of personal experiences that helps to shape its perspective. For the business school students who graduated this June, for example, COVID was a big part of those experiences; most of them were already employed in 2020, when the virus upended the world, and therefore had the opportunity to see how their companies responded to the pandemic and how that response played out. Then graduate school gave them the time and environment to reflect on what they’d seen and how it affects their views of the world. Their teachers, if they did their jobs well, forced them to develop, defend, and discuss many ideas related to business, including ideas based on that recent personal experience.
What you’ve experienced in the past has a profound influence on your expectations for the future. That notion has been well established in research by my Chicago Booth colleague Stefan Nagel. Nagel studies finance, but this line of research is based on a pretty big literature in psychology. It’s about the effects of your personal experience—your day-to-day life, the things that happen while you’re alive and that you didn’t just read about—on your beliefs, expectations, and predictions of the future.
Nagel studies this in two dimensions. One is an individual’s personal experience with inflation. He and his coauthors looked at predictions about the level and persistence of inflation. And presumably it’s fairly easy to learn about inflation that happened when you were two years old, or five, or before you were born, but that has a different impact on your beliefs about inflation than does inflation that you actually experience. The researchers demonstrate that there is a huge difference between individuals who are otherwise the same but who experienced different inflation during their lifetime.
Even experts are susceptible to this. In separate but related research, Nagel demonstrates that central-bank governors—who are somewhat educated about past inflation, or at least we would hope so—are influenced in their monetary-policy voting decisions by their personal inflation experiences.
Seek out and incorporate the perspectives of others.
Nagel also looked at how the performance of the stock market during your lifetime predicts how big a fraction of your investment portfolio you’ll put into equity. And sure enough, if stocks do well, you’ll likely put more into equity. If stocks did poorly in the past—in your past—you’ll likely put less in.
In short, the evidence is strong that personal experience is a big deal for the expectations you form and, in turn, the decisions you make.
One role of education is to help overcome the bias of personal experience. When students are exposed to other people’s experiences and decisions, and to ideas from faculty in wide-ranging disciplines, it can help them to counter the tremendously overweighted role of their own personal histories.
A former dean at Booth who’s now at Yale, Edward A. Snyder, told incoming MBA students: “You should complain vociferously if our research-oriented faculty are not doing research. And even more than that, not bringing their research into the classroom.” I think what he meant was that there are benefits of bringing together people with different perspectives and different views who have thought carefully about the same issue. It’s good advice.
Thinking about this as a teacher and researcher, I can say that discussion of these ideas in the classroom doesn’t just benefit students. Two of my own papers that I’ve learned the most from writing came out of teaching MBA students in my financial markets and institutions course and being unable to answer the question, “Why did this happen?”
I hesitate to generalize, but the most successful Booth alumni I know are those who implemented ideas that were very, very far from the norm in their industry. Being able to draw on different views, different beliefs, and different perspectives is important for innovation. When your thinking isn’t confined to the events of your own experience, you’ve got a major competitive advantage in an environment where you’ve got to get out first ahead of rivals.
Of course, personal experience is not in itself a bad thing. In fact, you may need some personal experience to understand and appreciate what you’ve learned in the past. When I hear from my former MBA students, it’s usually during financial crises, after they’ve experienced the issues that I cover in my class. They often provide interesting examples of how these things played out in their business and how they maybe were a little more prepared than others to figure out what to do.
Your experiences matter more than you may realize. The key is to use them to amplify and build on your knowledge, rather than being biased by them. Seek out and incorporate the perspectives of others, and you can benefit from the value of your experiences without giving them undue weight.
Douglas W. Diamond is the Merton H. Miller Distinguished Service Professor of Finance at Chicago Booth and a 2022 recipient of the Nobel Prize in Economic Sciences. This is an edited transcript of the speech he gave this past spring at Booth’s 2024 Graduation Ceremony for the Full-Time MBA and Stevens Doctoral Programs.
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