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BEHAVIORAL FINANCE AND MARKET DOWNTURNS PITFALLS TO BE AWARE OF
It may be a good time to remember the psychology behind investing. Behavioral finance explains why investors tend to react emotionally instead of rationally. There are dozens of emotional biases that may apply to investing. Let’s talk about a few of the more common ones that may come into play during or after a market downturn. 1. RECENCY BIAS Recency bias relates to our ability to recall information obtained recently more easily than information we received further in the past. The 11-year bull market in U.S. stocks that started after the financial crisis of 2007- 08 receded is a perfect example of this. Over the last decade-plus, most investors became accustomed to seeing nothing but gains in their investment accounts, so much so that many investors simply forgot the pain of 2007 and 2008. Some even believed it would go on for even longer. This, of course, is not (and never will be) the case. In recent months, markets across the globe were in a freefall due to the COVID-19 pandemic and trouble in the oil patch, bringing the bull market to a screeching halt. But remember: Just like the good times, the bad times don’t last forever. 2. HERD INSTINCT At some point in your life, you may have heard — or perhaps even posed — the question: “If everyone else jumped off a bridge, would you?” (I know I’ve been on both sides of that query!) Well, the truth is that when it comes to investing, many investors might say “yes” to that question. It’s tempting to base investment decisions — either buying or selling — on
what everyone else is doing, rather than performing your own research and analysis. Herd instinct is a result of the human tendency toward FOMO (or fear of missing out). 3. LOSS AVERSION Research from preeminent behavioral finance experts Daniel Kahneman and Amos Tversky shows that investors tend to feel the pain of financial loss far more intensely than they feel the pleasure of financial gain of the same size. Investors who have lived through painful market crashes may become fearful of further losses. This can lead to inappropriate investment decisions — such as pulling all money out of the market and into a savings account. Sure, money in an FDIC-insured bank account is safe, but it’s still not totally risk-free. Inflation risk — or the risk of the returns you earn from a savings account not keeping up with the rate of inflation — is a very real possibility. So, what’s the best way to avoid behavioral biases during challenging markets? Always revert back to your long-term plan to ensure you’re still on track to fund the goals you’ve declared. Continuing to check in with your plan can help you keep your emotions in check and prevent you from making decisions out of panic or fear. Reach out to us today if we can help in any way. Make it a great May!
1 https://retirement.tips/blog/behavioral-finance-and-market- downturns/
These articles are designed to provide general information on the subjects covered. They are not, however, intended to provide specific legal or tax advice and cannot be used to avoid tax penalties or to promote, market, or recommend any tax plan or arrangement. Please note that Patriot Wealth and its affiliates do not give legal or tax advice. You are encouraged to consult your tax advisor or attorney. Investment Advisory Services is offered through Retirement Wealth Advisors (RWA), a Registered Investment Advisor. Patriot Wealth and RWA are not affiliated. Investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. Consult your financial professional before making any investment decision.
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