"People rely heavily on the 'normal' way to compute an average and if they simply had ready access to software that calculates the average of ratios, they could make more informed decisions about many big-ticket purchases, such as cars," said Michael Tsiros, professor of marketing at the University of Miami School of Business Administration. "If you think about how many different ways we miscalculate the average of ratios, you'd realize how much of an impact this likely has on our stock purchase decisions that can also suffer from the same bias given they can also be compared as ratios," said Tsiros, who conducted the study with a colleague from Texas A&M University.

Methodology

The researchers conducted two studies to demonstrate consumers' difficulty in dealing with ratios. In the first study, participants were assigned word problems that, in order to arrive at the correct answer, required them to use the formula for averaging ratios. The majority, 53 percent of the participants selected the response that reflected the arithmetic average vs. the average of ratios. In the second study, participants received information on the cash cow, discount rate, and growth rate of three stocks and were asked to allocate $1,000 across them. Similar to the first study, 48 percent of participants' selections reflected the incorrect use of the arithmetic average formula.

"Whether the decision is about allocating funds properly to a 401K plan or finding a washer and dryer that uses a lower ratio of water per load, this study points to the significant need for something like a ratio calculator built on to relevant shopping websites or perhaps in-store," continued Tsiros. "Maybe it's an easy mobile app. Whatever it may be, the return that comes with going the extra mile for your customer, especially those making big-ticket purchases, is a smart business decision."