Out of Proportion: With Guests Damon Lesmeister & Kelly Shue

May 8, 2022
Non-proportional thinking, or focusing on absolute numbers rather than percentages, is just one way we get mixed up when we should be carefully calculating and comparing ratios.

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One thing to consider with stock performance is that it's not just what percentage the stock or even the entire stock market went up or down that matters. It's what's the impact on your portfolio.

One thing to consider with stock performance is that it's not just what percentage the stock or even the entire stock market went up or down that matters. It's what's the impact on your portfolio.

Many of the decisions we make require us to compare numbers. Which car is most fuel efficient? How is a stock performing relative to the market? How risky is one medication versus another? A problem arises when we fail to make these comparisons in the right units.

In this episode of Choiceology with Katy Milkman, we look at the mistakes we make when we overweight absolute numbers and neglect their relative value.

Damon Lesmeister is a wildlife biologist in Oregon who studies a very special bird: the northern spotted owl. This iconic animal is struggling to survive in the old growth forests of the Pacific Northwest. Among other challenges, the northern spotted owl is being crowded out of its habitat by an invasive species: the barred owl. Conservationists are now faced with a difficult decision, but one that is made more clear by properly comparing the relative sizes of the two owl populations.

Damon Lesmeister is a research wildlife biologist with the U.S. Forest Service and holds courtesy faculty appointments with Oregon State University in the Departments of Fisheries and Wildlife, and Forest Engineering, Resources and Management.

Next, Yale finance professor Kelly Shue joins Katy to talk about places where non-proportional thinking is likely to occur and why it's such an easy mistake to make. She explains how the dollar value change of a share is much less important than the percentage change. Focusing solely on the dollar value can lead to consequential investor errors.

Kelly Shue is a finance professor at Yale University and serves as an associate editor at The Journal of Finance and Journal of Financial Economics She previously served as an editor at the Review of Finance.

You can read more about non-proportional thinking in financial markets in Kelly Shue's research paper co-authored with Rick Townsend.

Finally, Katy discusses how you can avoid these non-proportional errors by making calculations that consider the denominator in any decision involving a ratio.

Choiceology is an original podcast from Charles Schwab.

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