If you had to choose what to invest in, whether to take on a certain form of debt, or whether to consumer (and how much), where would you go for info?
When we’re not sure about what to do, we look around us. We look to our left, to our right, and see what our neighbors, coworkers, friends and family are doing, and then make a decision. Finances, it turns out, are no different. It has to be mentioned though, that “looking to those around you” has changed quite a bit in the past decades. Whereas before the internet and social media our immediate surroundings (family, friends and those who lived close to us) where our reference points, things have slightly changed. Nowadays, we have constant access to what our friends, or anyone in our (online) circle is doing. Social media platforms such as Facebook give us a way to constantly follow and interact with people, even if they are thousands of miles away. And this is a game changer. Social networks are actually a massive source of information (e.g., Bikhchandani et al., 1992; Jackson, 2010). The reason for this is quite simple: many important financial decisions such as buying a home, taking out a mortgage, purchasing stocks etc., are rare, so most people do not have much, if any, experience in making them. It makes sense to look to others for advice. Also, your social network is probably delivering unbiased information and advice, unlike professionals, who have real or perceived conflicts of interest with those they are supposed to advise.
(Academic) research does bare out the idea that people turn to their social networks for help, on a multitude of financial decision making. Bailey et al. (2018) find that friends’ house price experiences can affect an individual’s own housing market assessments enough to substantially influence their housing market activity. These findings are in line with the findings by Bayer et al. (2016), who show that many new housing market investors entered the market as a result of observing various forms of investment activity in their own neighborhoods. This works with refinancing as well: Maturana & Nickerson (2019) find that a teacher is 20.7% more likely to refinance their own mortgage following a one standard deviation increase in the refinancing activity among her peers, and they also affect the choice of lender. This finding is consistent with McCartney & Shah (2019) who also provide evidence that households’ refinancing decisions as well as the choice of lender and loan type are socially influenced by a peer group of their hyperlocal neighbors.
Not all findings with regards to housing are positive. There’s negatives as well, which isn’t surprising as a lot of decision-making is (unfortunately) based on social comparison, also known as “Keeping up with the Joneses”. Research by Bellet (2019) finds that new construction at the top of the house size distribution in a neighborhood lowers the satisfaction that other residents derive from their own homes.
Now for most of my readers, buying a house and getting or even refinancing a mortgage is a bit ahead of the curve, so let’s dive into investing: Brown et al. (2008) and Hong et al. (2004) find that stock market participation is influenced by social interactions with close individuals. If your neighbours that participate in the stock market, you are also more likely to participate. This is not a game of mindless imitation (that would be terrible). Arrondel et al. (2019) find that peer effects in investing are largely driven by individuals learning about investing from their social circle. Kuchler et al. (2020) shows this as well, finding that social connections have the largest influence on investments of small investors with concentrated holdings. This is consistent with small(er) investors having fewer resources for systematic analysis, and therefore relying more on word-of-mouth effects.
From the self-directed investors to the pros: social networks still matter, don’t you worry about that! Pool et al. (2015) showed that valuable information is transmitted through these peer networks, allowing investors to outperform when investing in stocks they hear about through their local professional networks. Ivkovi ́c & Weisbenner (2007) document a correlation in the stock purchasing behavior of retail investors that live near each other. Similarly, Feng & Seasholes (2004) find that the behavior of Chinese retail investors is correlated with that of other nearby investors. So there’s definitely something going on…
Let’s look into a third (and the last) category of financial decision making: debt. Research by Georgarakos et al. (2014) showed that individuals who perceive themselves as earning less than the average of their peers have a higher probability of borrowing, simply to consume as if they were earning at least the average income in their peer group. Agarwal et al. (2016) showed that even winning the lottery can have an impact on your neighbors: They find that an individual’s lottery win increases subsequent borrowing and bankruptcies among the lottery winner’s neighbours, with the effects increasing with the size of the lottery win. Bertrand and Morse (2016), show that poorer households consume a larger share of their current income when exposed to higher incomes at the top of the local income distribution. It also aligns with the findings of Kuhn et al. (2011), who explore a Dutch lottery setting to show that when a neighbor wins the lottery, this increases the car consumption of non-winning neighbors. These are all examples of conspicuous consumption driven by the desire to “keep up”, as explained by upward social comparison. Let’s hope those damned Joneses never win the lottery!
It's not just academic research that shows a strong effect of social networks on financial decision making. A recent survey by CreditCards.com revealed that for 37% of Americans their friends and family are their main source of (financial) information. When looking at Gen Z, they cited social media as a go-to source. Maybe more worrying than that is that 31% of those surveyed said they got no financial advice at all. The survey showed that of those who get advice from friends and family, Gen Z lead the way at 53%, while millennials come in at 44%, Gen X at 37% and boomers at 25%. Additionally, 28% of Gen Z said they sought advice from social media platforms and influencers, while only 24% of millennials, 10% of Gen X and 4% of boomers said the same. On a household level, they find similar results: 45% of households earning $80,000+ said they got financial advice from family and friends, followed by 39% who turned to financial advisors. Whereas 32% of families making less than $40,000 said they got advice from family and friends, with 12% turning to financial advisors. Nearly half the respondents in the lowest income bracket (42%) said they don’t get any financial advice at all, compared with middle-income earners (30%) and highest-income earners (14%). Reading further down the survey, these findings become a bit ironic, as 70% of survey takers do feel that financial advisors are trustworthy (versus 16% who said they are not), 64% found friends and family trustworthy (versus 24% not), and 57% found financial websites trustworthy (versus 26% not). Whereas social media has the opposite rating on TripAdvisor: only 21% said that social media platforms are trustworthy (versus 65% who said they are not). So how come social media is still a popular place to go, whereas financial advisors are left out in the cold? (Jk, I’m sure they still make a nice bag).
Now let’s get to the part you’ve been waiting for: do social networks actually help you? Baker and Faulkner (2004) found that investors relying on social networks alone, without considering the underlying investment fundamentals, have a 39% risk of losses while considering the fundamentals reduces the risk of loss to 14%. With regards to debt all the examples mentioned above are indicators of applying upward social comparison, trying to keep and getting into debt as a result of it. As our social circle can now include anyone, rather than just those around us (often of similar socio-economic strata), this can turn problematic very quickly. I suggest you don’t follow too many millionaires on Insta. Sometimes your social network can function as a source of (somewhat) unbiased information. Friends can talk you through their experiences, recommend agencies or people to help you and so forth. But it is important to be aware of when social influences are affecting a decision and then consciously determine how much weight to give the advice. It’s also important to do your own homework. And if you don’t want to do your homework, have a professional do it. Seriously. Ultimately this is the advice I would give: - Do not follow ridiculously wealthy people on social media; - Do not follow the Joneses, whomever they may be; - Keep your friends close, and do ask about their experiences with certain complex decisions; - Keep your financial advisor closer; - And keep your finances closest!