Most people assume that financial decisions are made objectively, with investors pouring over spreadsheets and documents to make rational investment decisions, says SMU Cox marketing professor Milica Mormann. While this may be true in many cases, new research by Mormann and coauthors Bazley and Cronqvist reveals how the visual presentation of financial information impacts important financial decisions. Some of this influence, however, occurs subconsciously based on color stimuli, particularly in the use of the color red. The study found that red influences decisions on stock picks, expectations on both current and future stock returns and whether to purchase a certain stock at all.

“We wanted to show how people perceived the same objective values differently based on visual factors and how information is presented,” says Mormann. “So, it’s more than just color, it’s visual finance.” With more people managing their own investments on trading platforms such as Robinhood and E-Trade, she adds, people are buying and selling investment funds and stocks and making financial decisions. “Depending on which color is used [to display the information], it influences decisions differently in investing. Red is our case study.”

Mormann’s research contributes to a new field in financial economics dubbed “visual finance.” Visual communication of financial information is pervasive. Popular online investment platforms in the U.S., frequented by individual investors, show that financial decisions are made in colorful environments. Such color stimuli affect human behavior, evoking biologically ingrained evaluation processes in the human visual system. The researchers performed a systematic analysis of the effects of color in the domain of investor behavior.

Trading More Cautiously

With the pandemic ongoing, individual investors have been trading stocks now more than ever. The study showed that by displaying financial losses in red, individuals’ current risk preferences were reduced, and expectations about future stock returns were lowered. “We are the first study to show the color red not only influences the perception of current stock performance but that of future performance too,” Mormann says. These expectations contribute to “momentum” beliefs as investors who view past negative returns in red believe that the stock price will continue to decline. “When showing participants stock performance, if the information was in red, they projected a continued decline. When declining stock performance was depicted in blue or black, participants did not project a continued downward trend. Rather, they predicted that the stock would go back up,” says Mormann. “This effect held over a six-month timeframe. That’s pretty remarkable.”

Mormann’s research showed, in both hypothetical and incentivized experimental tasks, that red reduces individuals’ willingness to invest in stocks. A red color, compared to a black color, “suppresses” risk-taking behavior by 15% to 30% depending on the context. “In other words, red color causes avoidance behavior in investors, consistent with predictions from research in color psychology,” the authors write. Other colors, including yellow and blue, do not generate the same effects.

Interestingly, the effects of red are not present in colorblind individuals and are muted in China, where red represents prosperity. “The China context offered us the opportunity to remove the red bias to determine if it made a difference,” Mormann says, “and it did — since in China, there isn’t the same negative connotation of red that we have in the United States and many other Western cultures.” So, there wouldn’t be the same effect about risk aversion, stock performance and momentum beliefs in China by using red.

Additionally, investors who view potential financial losses in red may require a higher risk premium. For example, during periods of market declines, the color red is often used to visualize losses, possibly exacerbating investors’ aversion to risk. The research estimated that investors who view potential financial losses in red, compared to other colors, may require about a 25% higher risk premium than when financial losses are represented in other colors.

Different Stakeholders Have Different Goals

This line of research is important because, according to Mormann, there are multiple takeaways depending on which stakeholder group one belongs to. The research’s evidence has implications for the financial industry regarding the visualization of financial information and its impact on investors’ behavior. “If you are Robinhood or E-Trade and you want your subscribers to trade more, perhaps you don’t use red,” Mormann says. Colors may also have the potential to be used to manage investors’ trading demands, perhaps as cues which could either discourage trading or enhance entertainment value, the authors note.

The findings apply to individual investors who are increasingly managing their own investments via online trading platforms. “If you are an individual investor, perhaps you can change the color depicting information or just be aware of the red bias,” Mormann says.

For public policymakers and regulators, the evidence suggests that color could be an important and a relatively inexpensive “nudge” for financial decision-making. “Perhaps social security statements display some red illustrating the need to save more,” she says. “Or, to encourage saving more, perhaps you display information that shows someone is spending more than their peers.”

Depending on the goals of differing stakeholder groups, the visual presentation of financial information can be altered to address biases, heuristics and other cognitive limitations of investors, Mormann says.

The paper “Visual Finance: The Pervasive Effects of Red on Investor Behavior” is forthcoming in Management Science and is authored by SMU Cox School of Business’ Milica Mormann, University of Kansas’ William Bazley and University of Miami’s Henrik Cronqvist.

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