In 2008 we were faced with a black swan event. Fast forward to 2020, we are now in the midst of another one.
But no one saw this black swan event coming.
Naturally, most people are feeling some degree of panic. We are being bombarded constantly with new information and the rate at which new events are developing doesn’t help either. These situations can bring out the best in some and the worst in others. It’s only natural to start questioning everything.
It may be hard for advisors to focus when they’re hearing from clients who are feeling increasingly anxious about their investments. But I want you to avoid falling into the same behavioral biases that might be clouding your clients’ judgment.
These are the biases that I believe are most prevalent right now, for investors and advisors alike.
#1 Loss Aversion Bias: The pain of loss is twice as psychologically powerful than the pleasure of gaining, according to Behavioraleconomics.com.
During a market crash, investors are more willing to take risks by pulling out their money if it means avoiding a short-term loss. Unless you have sold out of positions, you have lost nothing. Most of you have created a plan that’s strong enough to withstand a situation like this!
#2 Mental Accounting Bias: Rather than thinking of their money in terms of the “bottom line,” people treat money differently depending on factors like where it came from and its intended use, according to Richard Thaler’s theory of mental accounting.
I bet you are totally falling into this bias right now! You are looking at accounts individually instead of as a part of an overall plan.
#3 Snakebite Effect: “Once bitten, twice shy” captures the human reaction to this bias. Investors who have a negative experience with an investment might take on an ultra-conservative approach going forward.
We are all feeling the sting of a bite here, but anyone who went super conservative with their investments after 2009 missed a lot of amazing growth that the stock market has had since then.
#4 Illusion of control: People who fall into this bias believe they have influence over random events that they have no true power over. Factors that strengthen this bias include the familiarity of the situation, the type of outcome, and people’s personalities and moods. This illusion of power can spur investors to take unnecessary risks.
Let me ask you this: What can you actually control in this present situation? How is this really going to affect the long-term plan you created?
#5 Recency Bias: This bias is a psychological phenomenon in which people can most vividly remember recent events. People are then prone to using recent events as a baseline for making decisions.
We are living in this bias right now. investors have already forgotten that their portfolios have been screaming straight up since 2009. In the last three years, what has the real rate of return been?
Final notes, keep your head, communicate a lot about what you are doing, remember doing nothing is something. If there is anything I can help you with, please message me on LinkedIn.