Pluralistic Ignorance and Its Impact on Investor Behavior

When I first started graduate school and met the other students in my cohort, I was blown away at how smart, clever, and experienced they all were. Only a few days into our orientation, I started to develop the sneaking suspicion that I didn’t really fit in – that somewhere along the way, the admissions committee had made a mistake by offering me admission. Perhaps they failed to really look into my file, for if they had, they surely would have realized that I wasn’t cut out for a Ph.D. in psychology!

Then, a few weeks later, while sitting in a small lecture with the other first-year students, a professor posed a question to us: “How many of you,” he began, “have at some point since arriving on campus felt like you didn’t deserve to be here – that there was a mistake, and you don’t actually belong in this program? And be honest!”

There were 14 of us in the room, and 13 hands immediately shot up. (It’s possible that the 14th student wasn’t paying attention, or maybe she was just really confident.) In any case, it was an incredible demonstration of something that psychologists call pluralistic ignorance.

Although my professor introduced it to counteract the feeling that we were all impostors, it’s a concept that seems particularly applicable during times of volatility, whether the market is more bullish or bearish.

Pluralistic Ignorance in Behavioral Finance: Definition and Examples

Here’s the basic idea: You hold a private belief about something, but because you don’t hear others voice the same belief, you assume they don’t feel the same way when in reality, they actually do.

In my example, I experienced impostor syndrome, but because none of my friends said anything about how they felt that way, too, I assumed I was the only one who stood out. Likewise, they each thought that they were the only impostors.

A classic demonstration of this phenomenon was shown in the early 1990s at Princeton, a campus known for its heavy drinking culture. In that particular case, researchers found that most Princeton students were uncomfortable with prevalent binge drinking. Still, because they didn’t hear others speak up, they assumed they were alone in this belief.¹

So, because no one voiced any issues, everyone assumed everyone else was fine with the heavy drinking, even though most people actually weren’t.

How Pluralistic Ignorance Shapes Investor Behavior

The pluralistic ignorance phenomenon quite clearly applies far beyond college drinking culture! Imagine how this sort of process could easily play out in a variety of investor scenarios.

What if, for instance, you (or a client) believe that a particular stock or sector is undervalued and about to take off? That belief could feel like a personal insight or an edge. What they might not realize, however, is that thousands of others might also privately hold that belief.

Suddenly, that particular space becomes crowded, and the stock or sector shoots way past its fair market value. If that sounds abstract, think about meme stocks or the tendency for investors to pile money into artificial intelligence (AI) companies in 2023-2024.

Or consider a more personal example: Imagine that one partner in a couple has grown quietly uncomfortable with the household's spending habits – the vacations are getting more lavish, maybe the renovations more frequent. But because the other partner hasn't said anything, the uncomfortable one assumes their partner is perfectly happy with the spending pattern.

What they don't realize is that their partner may hold the same private unease. Neither says a word, so the spending continues – not because both partners endorse it, but because each is misreading the other's silence as agreement and satisfaction.

You could also imagine how the phenomenon could play out with risk tolerance. Perhaps a client is more risk-averse than they feel comfortable reporting because they falsely believe their peers are bolder than they are, so they let a more aggressive plan or portfolio allocation stand. The advisor, having heard no protest, has no reason to modify the plan or portfolio.

How to Reduce Pluralistic Ignorance: Strategies for Better Decisions

I’m sure there are other examples I haven’t listed here. But the real question becomes: What can be done about this deep-seated problem?

Make private beliefs public. For starters, we can take a page from my grad school professor’s playbook: Simply bringing privately held beliefs to the foreground can go a long way toward changing attitudes and behavior.

In one research study that followed up on the original Princeton research, incoming freshmen were asked to talk about their attitudes and behaviors around drinking in a group with other new students, and they were educated about pluralistic ignorance.²

Another group of students was simply asked to talk about their own drinking behaviors with others, without any education surrounding pluralistic ignorance. Four to six months later, the students involved in the group discussions, where they learned about pluralistic ignorance, reported drinking less, precisely because their assumptions about other students’ beliefs had been revised to better align with reality.

One way to combat pluralistic ignorance, then, is to clarify, when possible, what other investors actually believe. But don’t just spotlight average sentiment; instead, show a client a distribution of beliefs and ask them where they might fall on the spectrum.

Give permission for true beliefs. If you sense a client’s discomfort with a particular topic, it may be helpful to give them space to express their true beliefs. “What’s your real worry right now?” or “Do you feel out of step in any way?” are just two starter questions that could help.

Point out historical examples. Bring up other times when investor behavior seemed to suddenly not be in line with previously held beliefs. Doing so could help a client recognize how past scenarios might be similar to a current one.

We can never truly know what others are thinking or feeling. Part of being human is making educated guesses about what exists in our peers’ minds – perspective-taking is surely at the heart of strong relationships.

Problems arise, however, when we operate on assumptions about other people’s beliefs, failing to recognize that we’re actually more similar to those around us than we think we are. And it’s that disconnect, or pluralistic ignorance, that can lead us to act when we should stay put or not act when we really should.