Improving Investor Behavior: Mindsets during volatile times


If you’re an investor (and I hope you are), it’s probably time for a mental check-in. How are you today? How do you feel about everything going on in the world? There are many reasons to be fearful or upset:

  • Stocks are in a “bear market,” including well-known blue-chip companies.
  • Bonds are getting pummeled.
  • Inflation is at a 40-year high.
  • Interest rates are rising.
  • There’s a war in Ukraine.
  • There are legitimate fears we are heading for a recession.

Have these catalysts caused you to question your investments? Your financial plan? During times of stress, investors tend to fall back on emotion and a herd mentality. We default to behavior that seems “safe” but rarely serves us well. As a result, under even mild pressure, people generally make worse decisions.

Steve Booren
Steve Booren

One study found something as innocuous as poor weather impacts investor behavior. On cloudy days there is an increase in the perceived overvaluation of the markets for both individual stocks and the market. This leads institutional investors to make more sales on cloudy days when gloomy weather triggers gloomy emotions. If the weather can have a measurable effect on investor sentiment, imagine what the evening news can do.

It’s essential to recognize that in the short term, emotions determine market prices. Over the long term, earnings determine market prices. Described another way: Emotions drive the stock market over shorter timeframes, but fundamentals drive the stock market over longer timeframes. This shouldn’t be a surprise, but instead, a reminder: The stock market can always get crazier. The prospect of making or losing money can cause people to act in bizarre ways.

For example, “Origins of Stock Market Fluctuations” by the National Bureau of Economic Research examined the correlation between emotion and market performance back to 1952. Three factors explained 85% of the market’s moves over time:

  • The productivity of the economy (which only matters over the very long term).
  • How much of the rewards of the economy end up going to household investors through income, dividends, or gains.
  • Risk aversion, which indicates how humans react unfavorably to uncertainty.

The study concluded that historically, roughly 75% of the variation in the stock market over the short term could be explained by risk aversion. In other words, investors resist risk. This makes sense: We often avoid risk if we can. The trouble is we’re not all that great at measuring potential risk.

Numerous studies have shown humans are terrible at forecasting risk and future emotions. Actual experiences of events are typically less scary than we imagine them.

In his book “The Science of Fear,” Daniel Gardner talks about the “Example Rule,” wherein the more easily we’re able to recall examples of something happening, the more likely we perceive it to happen again. This creates a fear-based feedback loop that causes us to overestimate the likelihood of being killed by the things that make the evening news. Murder, terrorism, and pandemics become more likely causes of death for us than diabetes, obesity, or heart disease.

Similarly, the more we hear about the stock market “crashing,” the more we believe it will.


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