An interesting question caught my attention during a recent economic outlook presentation I attended: “Is the stock market grounded in reality? Or are we seeing irrational exuberance?” Whoa. I hadn’t asked myself these questions as succinctly, but this posed a good question.
Is the stock market currently grounded in reality? Is it ever grounded in reality?
The study of behavioral finance questions whether the stock market/investors are rational. I spent a good portion of 2019 studying behavioral finance while earning my CIMA® certification, and I firmly believe that the stock market can be irrational. During times of volatility, these reactions can be magnified, leading to losses and regrets. Here are a few common biases to watch out for these days:
Confirmation bias: a selective perception that emphasizes ideas that confirm our beliefs while devaluing info that contradicts our beliefs.
Like the old saying, “you only hear what you want to hear.” Ex. Holding large dollar amounts in one company’s stock because you’ve heard that there’s great upside while selectively ignoring the downside.
Self-attribution bias: the tendency of individuals to ascribe their successes to internal characteristics like talent while blaming failures on outside influences like bad luck.
We all do this, but patting yourself on the back every time that market rallies could lead to overconfidence in your (potentially non-existent) skills as an investor resulting in large losses when the market falls.
Recency bias: the predisposition for our brains to recall and emphasize recent events and observations more than those in the past.
During volatility, this can lead to panic selling or emotional buying.
This goes both ways in that we typically favor our present self over our future self. (Like splurging on a vacation while holding off on additional retirement savings!)
There is a lot that is going on in the market, the economy, and the world. Things are literally changing day by day. We’ve had a bit of a market rebound since the big dip in March, but I don’t think we’re out of the woods yet. We have a long way to go before we reach our new normal. I’d love to see if we can help you cut through the noise and avoid falling prey to your biases. CLICK HERE if you think we can help in any way.