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During these difficult times, especially during a Coronavirus triggered a recession, many of us make poor investment decisions that can be biased based on our emotions of greed and fear. Smart investors, per Warren Buffet, should be “greedy when others are fearful and fearful when others are greedy”. In other words, by low and sell high. Sounds simple, but as Stephen Covey says, “what is common sense isn’t common practice”.
So why do investors make so many emotional investment mistakes – especially when worried about the economy or even possibly layoffs. When it comes to your finances, “go with your gut” might not be the wisest adage to follow. In fact, it may work against you, particularly in periods of market turbulence. Before jumping to conclusions about your finances, consider what biases may be at work beneath your conscious radar. Much of this can be explained through the science and research of Behavioral Finance. Below I will talk and summarize some areas that I read in a Morningstar Report titled “How Behavioral Science Can help (investors and) Advisors During Market Turmoil. These behavioral biases, described and summarized below, may be adversely impacting your financial decisions and possibly derailing your Financial Plan while you are riding this Stock Market Roller Coaster.
One example of these behavioral bias is Recency bias that refers to the tendency for recent events to have a stronger influence on your decisions than more distant events. For example, when the market was in the midst of an 11-year bull run, you may have increased your investments in equities, hoping to take advantage of any further gains. By contrast, if you were severely burned by market performance during the past several weeks, you may be hesitant about continuing or increasing your investments once the market settles down. Consider that neither of these perspectives may be entirely rational given that investment decisions should be based on your individual goals, time horizon, and risk tolerance.
Loss-aversion bias describes the tendency to fear losses more than celebrate equivalent gains. For example, you may experience joy at the thought of finding yourself $5,000 richer, but the thought of losing $5,000 might provoke a far greater fear. Loss aversion could cause you to hold on to a losing investment too long, with the fear of turning a paper loss into a real loss. In a down market, of course, most of your investments may show paper losses, so you might consider whether you are holding on to an investment that would be wise to sell within the context of your overall strategy.
It’s only natural to be concerned when the market drops. But expecting volatility and having a sound financial strategy in place may be the best defense when events roil the markets. This might also help prevent you from making investment decisions influenced by biases.
If you think you might be basing your decisions on biases rather than facts, contact us. We can offer an important third-party perspective by helping you align your investment portfolio and decisions with your overall financial plan.
All investing involves risk, including the possible loss of principal, and there is no guarantee that any investment strategy will be successful. However, if you truly have a plan and thoughtful portfolio allocation aligned with that plan, you most likely will have a higher level of success and avoid “buying high and selling low”.
Although there is no assurance that working with a financial professional will improve investment results, a professional can evaluate your objectives and available resources and help you consider appropriate long-term financial strategies.
List of Ten of the Behavioral Biases that may be Influencing your Investment Decisions:
Disclaimer: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC (“STA”), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. STA is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. If you are an STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services.