Halo Effect and it's Impact on Investment Decisions
Created on 09 Oct 2020
Wraps up in 5 Min
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Updated on 10 Oct 2020
“The first impression is the last impression”. Do you know why our family, teachers or well-wishers always say this? Well, the reason behind it is that often, snap judgments are a human tendency, and people try to perceive others in the first meeting itself. Therefore, initial perceptions are always important, especially in job interviews. If the interview of an individual goes outstanding, and he performs well in his initial tasks, the employer may reward him with a higher job role, pay, and responsibilities. This decision of the employer will be taken under the perception that the person will be able to live up to their expectations.
Another field where a lot of perceptions are made is the cinema world. Regular cinema buffs, often tend to have preconceived notions and perspectives related to most movies. For example, if it’s a Salman Khan movie, then we often already know that it will be a high grossing action film. If it’s a Shahrukh Khan movie, then it will most probably be a romantic one.
We all make such assumptions in everyday lives. This is something we can relate to the Halo Effect.
Let’s take a deeper dive into this topic and understand more about the Halo effect.
What is the Halo Effect?
The Halo effect is a cognitive bias which influences our perception about a person, product or a company by concentrating on just one personality trait or feature of that person or product.
The Halo effect is not just limited to job interviews and movies; it can majorly be seen in the business world, where one famous product of a company helps in adding consumers to the other products of the company as well.
Due to such situations, we can say that the halo effect is similar to brand loyalty and brand strength and often also contributes to brand equity.
How does Halo Effect works?
The halo effect is created by companies when they try to capitalize on their existing strengths. Companies try to market their new products via their already existing, high performing product.
When a product is doing well in the market and consumers have a positive experience in using the product of that brand, the company then cognitively forms a brand loyalty bias in favour of that particular brand and its respective offerings.
This belief of consumers has nothing to do with experience but is based on the assumptions that if a company is outstanding in one thing, then it will definitely be good in other things as well. Such perceptions help in building a more powerful brand.
This halo effect is used by companies to establish themselves in their respective industries. Due to the halo effect, the businesses will apparently be able to gain a good market share and increase profits.
Another advantage of the halo effect can be when the consumers refuse to buy products from the other potential competitors of their chosen brand.
Examples of Halo Effect
The Halo effect can be seen almost everywhere. In the electronic industry, Sony Corporation is a great example. Sony’s products are favourable all around the world.
People often think that the company already has a list of successful products; therefore, the upcoming product will also be good and satisfying. They feel so before even using that product.
Another near-perfect example could be of Apple. The company’s iPod has really helped it to mark its own legacy. The Halo effect has not only helped Apple to become a successful giant but has also made it a symbol of luxury and style.
Most often, when the halo effect comes into the game, the failures of big companies often get hidden, as the market becomes too obsessed with their better product/service. This is another merit of the halo effect.
What are its Implications?
The halo effect, which mostly seems as something which can have no negative effects, could be a problem when it leads to blunders in the investing process.
Yes, the halo effect can sometimes also lead to some grave mistakes in the investment process, but such mistakes can be avoided easily. The various examples of the influence of the halo effect in stock investing are enumerated below:
- Companies which have familiar ticker symbols try to trade at higher values than the companies which have difficult to remember ticker symbols.
- Another important factor through which even the seasoned investors are also influenced is the likeability of the CEO. Very often, big M&A deals tend to get influenced by the likeability factor.
- Many times there have been situations where the stocks of a company suddenly take a jump after adjectives like “expansion”, ”forward integration” etc. are shown in the news. In such situations, the investors invest without thinking and often end up losing their money.
- A market crash is also something which leads to the failure of stocks since the investors get influenced against investing. After any market crash, the investors become a victim of panic and risk aversion. Due to such induced panic, the investors make some mistakes in judgment and rather than buying more, they wait and as a result, often miss the good opportunities.
- Even intelligent investors get biased in investing and tend to make a judgment about a company based on just one report. Even if the other reports show some blunders, the investors fail to notice that as they did not make an analysis of that report.
What can investors learn from the Halo Effect?
There is a list of lessons for prudent investors. If you are an investor and don’t want to be affected with the halo effect, then do remember the following points:
- Do not depend on anyone. Make your own analysis.
- Don’t blindly trust the experts. They can also make wrong predictions.
- Never make the mistake of getting emotionally attached to the stock because you have owned them for a while. Active trading is always healthy. Do not just buy one stock and cling to it.
- Try to be more careful when you hear of any businesses being touted with phrases like “next Infosys”, or “the next sun pharma”. Buy with safety and always look at the fundamentals.
- A holistic analysis is always the best way. Therefore, always look holistically at a company before investing.
- Avoid getting influenced by any information that has nothing to do with the business. Many times, investors don’t purchase stocks of one company just because the owner of that company has a controversial personal life.
Whether it is about movies, job interviews, personal judgments on someone, travel destinations, food of a particular restaurant or stocks of a company, perceptions are everywhere.
As mentioned earlier, snap judgment is a human behaviour and perceptions help in that. Halo effect is a blessing when it becomes one of the core reasons for the success of a company. But at the same time, it can also become a curse when it influences a person to make wrong investing decisions.
So, if you are an investor and want to prevent yourself from the scourge of the halo effect, then don’t let the halo effect solely be the reason for your investing or not investing in a particular company.
Happy (and smart) investing!
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