Human behavior can be puzzling. Psychology can boost one’s spirit or inhibit one’s character. A few psychology courses can go a long way to help you become a better investor. Sounds odd, but the financial markets are just people deciding to buy or sell securities.
Investing seems straight forward and logical. In reality, trading can be hampered by mental acuity and emotional fitness. Warren Buffet said, “Investing is simple, but it’s not easy.” “Simple” in that the goal is to buy low and sell high, but “not easy” as the market is in a constant state of flux amplified by the human mind.
Much of that volatility, at least in the near-term, is based on individuals’ decisions. Decisions, by their nature, require human brain power, which is entwined with how the brain works, a.k.a. psychology. In fact, the study of psychology upon the investing world has gained momentum over the years into its own brand of course work known as Behavioral Finance. Understanding how our brains work will help guard against your own demons as well as recognize the market’s illogical happenings.
Currently, there seems to be at least a couple psychological forces influencing the markets. The first is Recency Bias. Recency bias is the notion that people overemphasize on recent events. Recency bias may lead investors to think that the current stock market downturn will extend indefinitely. Recency bias can lead clients to make short-term decisions that deviate from their financial plans. The best way to defend against recency bias is to 1) realize recency bias exists, 2) focus on your long-term plan, and 3) resist the urge to make knee jerk reactions, even if you feel they are informed knee jerk reactions.
A second current psychological factor is herding. This one is so fundamental it goes back to early humans. Being herd animals, we relied on individuals in a group to inform the whole group, even non-verbally. Spotting a tiger in the distance might have been enough for one person to run, prompting everyone else to do the same without having to re-evaluate the situation. Those ancestors that didn’t were rewarded with the termination of their genetic line.
Today, most of us don’t have to worry about a pouncing tiger, yet the herding mentality is still within us. When, large market declines happen, many start running without stopping to think, “what are we running from?” The downdraft can be exasperated becoming a self-fulfilling prophecy. The best way to defend against this is to 1) recognize herding exists, 2) focus on your long-term plan, 3) resist the urge to make knee jerk reactions, even if you feel they are informed knee jerk reactions.
Prescriptions to curb behavioral influences are the same. First, recognize we are human and subject to human psychology. No one in infallible. Second, remain focused on what is important. Your portfolio was designed with volatility in mind. Lastly, the current situation will not last forever. Today’s podcasts offer a plethora of topics. Listening to a behavioral finance podcast may help your investment success and teach you something about yourself.