The Memory Trap: Why Investors Keep Betting on a Flawed Past
Think of an investor who remembers all the years in which his or her portfolio gained in value but forgets the ones in which it lost in value. This could influence how the investor forms expectations about future outcomes and eventually how the investor makes investment decisions.
This, in essence, is what the new research paper “Investor Memory”, by Katrin Gödker (Bocconi Department of Finance), Peiran Jiao (Maastricht University) and Paul Smeets (University of Amsterdam) and published in The Review of Financial Studies reveals: our memories of investment outcomes aren’t just imperfect—they're biased. And this bias has real consequences.
The hidden power of selective memory
The study uncovers that people “overremember positive investment outcomes and underremember negative ones”. In simpler terms, investors view their past through rose-tinted glasses.
This can hurt their performance. Based on their memories, form unrealistically optimistic beliefs about their investments, become overconfident in their investing abilities compared to others, and reinvest too much in their risky assets.
The methodology
The researchers conducted three lab and online experiments involving hundreds of subjects across multiple countries. The experiments were designed to mimic real-world financial choices. They investigate the complete chain: what investors remember, how they form expectations based on these memories, and how this then translates into decisions.
To identify a memory effect, the researchers vary time spans. They ask subjects to report their recall of investment outcomes either in a control group immediately after the observation or in a treatment group one week after the observation. In this treatment group, subjects have one week time to form memory about their outcomes. The researchers then compare subjects' recall in the control vs. treatment group. This isolates the real effect of memory from alternative factors, such as attention or salience, that might influence what individuals recall.
One week after observing their outcomes, respondents remembered on average 23% more gains and 10% fewer losses than actually occurred. As the authors note, this positive memory bias “offers a cognitive foundation for why gains weigh more than losses when people learn from experiences” in financial markets.
The psychology behind the bias
Why does this happen? The researchers state two key reasons in line with motivated memory:
- Active choice: Investors want to feel good about their choices, especially those they actively make. In the experiments, people showed the memory bias only when they had chosen the investment themselves—not when it was assigned to them randomly.
- Memory suppression: People seem to “suppress memories of negative outcomes rather than actually forgetting them,” especially when the truth threatens their self-image as competent investors.
Katrin Gödker adds that “people frequently ignore available information, because of the so-called ostrich effect, regret aversion, or the motive to maintain positive feelings. When people do not look up objective information, they might make investment decisions that are misguided by their subjective memory.”
Lessons for non-traders
“Memory […] is the diary we all carry about with us.” ― Oscar Wilde
Even if you’re not a serious trader, there are lessons to learn. Any time people look back on past decisions—be it financial, professional, or personal—they are likely to do so through rosy glasses: people remember what they want to believe.
This positive memory bias can have significant implications for how people learn from past experiences. As the authors put it, “If investors forget their losses, they cannot learn from their failures”. The same is true for CEOs and overinvestments, gamblers during losing streaks, or car drivers with frequent speeding tickets.
A call for reminders
For regulators and financial advisors, this study underlines the importance of not just informing investors, but reminding them—reliably and accurately—of past outcomes. After all, memories fade, but financial consequences don’t.
