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Staying the course: The psychology behind successful investing

 
Do you panic when the market takes a dip? Learn how to stay calm and on track.

 
June 2022 5 min read

Market dips happen, and it’s completely normal to feel nervous when they do. After all, declines in portfolio performance are always stressful, even if they’re only short-term. But it’s important to recognize that our emotions can have a surprisingly big impact on how we behave. These are known as “behavioural biases” in psychology. During the uncertainty of a market downturn, they can unconsciously sway our investing, causing us to make decisions we normally wouldn’t.

The trick to keeping these influences in check is awareness. Knowledge is power and learning how biases work can help you take control to ensure they don’t affect your investing strategy long-term.

How history can help us stay the course during a dip

Before we dive into the world of investor psychology, there’s one important thing to remember during a downturn. When financial markets are a little rocky, it’s easy to get caught up in nerves and feel that the current dip is particularly significant (this is actually connected to the recency bias we’ll talk about soon). But history has taught us different – and it’s one of the best teachers we have.

Whether you look at 2008, 1992, the Great Depression or further back still, you will find that market downturns don’t last forever. In fact, markets have historically rebounded stronger than before. Remembering this during a dip is often your best strategy to combat behavioural bias and prevent it from clouding your investing judgement.

3 behavioural biases to beware and how to avoid them

  1. Bias for action

When we’re stressed, uncertain or overwhelmed by a situation, our first instinct is often to do something about it – even if there’s no evidence that taking action will make things better. That’s because decisive action makes us feel more in control. This is known as the action bias.

  The action bias at work

A soccer goalie faces a penalty kick. To stop the ball, they can dive left, right or stay in the center. Statistically speaking, staying still offers the best odds of making the save, but studies show the goalie will dive almost every time.

In investing, the “early dive” will often take the form of an inadvisable portfolio decision during a market dip. Even if doing nothing is the best strategy, media and investor panic can make it difficult to stand firm and stay the course.

How to avoid action bias

Change the TV channel, close your favourite financial websites, stop checking your portfolio daily. By limiting how often you engage with news sources during a downturn, you avoid the general rush and urgency that can trigger your instinct to take immediate action.

  1. Recency bias

As humans, we naturally live in the now. What happened to us today or recently feels much more real and important to us than distant events. This means that we’re likely to remember and rely on fresh memories to back up our decisions, even if we have more relevant past experiences to draw from.  

  The recency bias at work

An investor looks at their portfolio during a market dip. To determine what to do, they can focus on:

  • The last month’s data showing a drop in performance
  • Data from the 1992 and 2008 dips showing strong market recovery

Studies have found that many investors will trade based on the recent poor performance – hurting their portfolio when markets rebound.

How to avoid recency bias

Pause, think, and evaluate the situation from all angles. Looking at both current events and historical market data will ensure you get a better informed and more well-rounded perspective on how best to manage your investments.

  1. Overconfidence bias

Confidence isn’t a bad thing. In fact, it can be crucial to success in life, helping us excel in our chosen fields and tackle any challenges we face. But, contrary to the popular phrase, in the case of confidence you really can have too much of a good thing – because overconfidence often leads us to trust our own instincts over empirical evidence and others’ experience.

 The overconfidence bias at work

An investor sees a downward market trend. They have friends who sold off investments during a past dip and regretted it when markets recovered. But the investor believes that’s because those friends didn’t have the knowledge they do, so they sell off their investments too.

How to avoid overconfidence bias

Get a second opinion from a professional. Advisors have training, experience, and access to market insights you don’t. By running your investing plans by them, you’ll be able to validate that your decisions are based on concrete knowledge and not overconfidence.

Staying the course isn’t easy for any of us when markets dip—especially when everything from the media to our own brains tell us to panic. If you’re feeling worried about the markets, need a second opinion on an investing decision, or simply want to review your strategy to be sure it’s sound, our experienced advisors are here to help.