Giving Compass’ Take:
• Matthew Lee and Jasjit Singh explain common barriers too effective impact investing and how investors can overcome them.
• Is your impact investing suffering because of these barriers? How can you shift your strategy to better achieve impact?
• Learn more about impact investing.
Financial markets run on the often-unspoken assumption that human beings make perfectly rational decisions that drive capital to the highest-performing enterprises. Indeed, the finance field promulgates an image of dispassionate investors who tirelessly comb through opportunities and seamlessly integrate information to optimize their portfolios.
This hyper-rational ideal does not reflect reality. Evidence shows that systemic biases in investor decision-making lead to costly misjudgments. In the realm of investing to achieve social and environmental impact, definitions of performance are often more ambiguous and information less complete than in traditional investing. Emotions come into play in new and complex ways. These cognitively challenging factors introduce new biases that can lead to misjudgments.
Building on the principles of prior decision-making research, we and others have begun to study biases that affect impact investment decisions and how they might be overcome. Here we offer some observations and recommendations based on academic literature, conversations with practitioners in the field, and our own research.
Think about the moment when you were first inspired to become involved in social impact. Maybe it was while reading through the profiles of low-income entrepreneurs seeking support on a crowdfunding platform. Perhaps you watched an inspiring video about a social enterprise or impact-oriented business. Almost certainly, you were drawn in, at least in part, by the feelings you have about making a difference. These pleasant, fuzzy feelings we associate with doing good are what decision-making researchers call “warm glow.”
Warm glow is essential to impact investing–it is the cognitive basis for why we are interested in doing good in the first place. But warm glow can also lead impact investment decisions astray. This is because its cognitive rewards are based on acting on our good intentions, not the impact that those actions produce. Because our experience of doing good does not perfectly mirror the impact that they produce, warm glow often leads to decisions that create some positive impact, but not as much as they could.
For example, one of our recent research studies compared how customers of a ridesharing platform responded to two types of promotions. The first offered a cash discount. The second offered a charitable donation to be made on the customer’s behalf. While customer response to discount-based promotions grew rapidly as the size of the discount increased, response to charity-linked promotions increased much more slowly as the size of the donation increased. This is consistent with the “warm glow” phenomenon: Customers received warm glow from the mere act of giving, largely irrespective of the magnitude of help provided, as represented by the amount of the donation. In another study, participants were allowed to allocate a certain amount of money across a set of charities—which varied in the actual impact per dollar received—however they wanted. Most gave small amounts to many charities, which allowed them to receive the warm glow associated with each individual act of giving. However, they would have maximized their impact by focusing their giving on the most effective charities.
Read the full article about barriers to effective impact investment decisions by Matthew Lee and Jasjit Singh at Stanford Social Innovation Review.
Learning and benchmarking are key steps towards becoming an impact giver. If you are interested in giving with impact on Impact Investing take a look at these selections from Giving Compass.
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