Similarity Heuristic – Its same as that


Similarity Heuristic

The similarity heuristic is a lesser-known psychological heuristic pertaining to how people make judgments based on similarity. More specifically, the similarity heuristic is used to account for how people make judgments based on the similarity between current situations and other situations or prototypes of those situations.

At its most basic level, the similarity heuristic is an adaptive strategy. The goal of the similarity heuristic is maximizing productivity through favourable experience while not repeating unfavourable experiences. Decisions based on how favourable or unfavourable the present seems are based on how similar the past was to the current situation.

http://en.wikipedia.org/wiki/Similarity_heuristic

When faced with a decision making situation, where we are confused with multiple choices to make, we human beings usually tend to fall back immediately on our past experience of similar or any such comparable situation of the past to make decision. That may be entirely applicable to present situation or at least we tend to pick some pointers to resolve the current problem or make decision.

Similarity Heuristic in daily lives

  1. When purchasing a book, we will be influenced by our recent experience from reading a book and may look for to buy a book of the same author or story line
  2. Investing or avoiding to invest, in companies of similar business because in the past we have experienced either a profit or loss of a company that operates in similar business
  3. Investments made in technology stocks during the dotcom boom, and once made some profits, people went ahead and invested a lot in newer dotcom companies, as all those were similar and people expected similar returns as they got in the past.
  4. Most of us solve the problems based on this heuristic – that is a positive one – as we get to know the facts and data of past problem’s solutions, which could be applied in the current situation
  5. Picking a restaurant of same cuisine based on our past experience of the same cuisine in some other restaurant

Overcoming Similarity Heuristic

  1. Check if this heuristic is going to help solve your problem and make decision making easier. If yes, then go ahead – nothing wrong with this heuristic in this situation
  2. Cross check with past facts and figures to make sure it would help in current situation. Only then plan to use those facts and figures in decision making in present situation

My Experience

During 2005-08, I made some investments in infrastructure stocks and during its initial run-up, I sold and made some profits. So, I thought of all infrastructure stocks are similar and again I invested in infrastructure stocks and MFs. Few of them did well, and many of them did not.

 

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Filed under Behavioural Finance

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