Like it or not, the market is driven by investors' emotions. When sentiment is optimistic and opportunistic, stocks tend to soar. But when it sours, investor panic can lead to major market sell-offs.
A recent survey of financial advisors conducted by Schwab Asset Management uncovered an increase in behavioral biases among investors—likely driven by the ongoing pandemic and economic uncertainty. "It's normal to have emotional and even irrational reactions to unsettled markets because we are all human," says Omar Aguilar, CEO and chief investment officer of Schwab Asset Management. "But controlling your response to uncertainty is key to your portfolio's long-term success."
Here are three well-established emotional biases you should be particularly wary of now:
- Herd mentality: Sticking with the group was critical to the survival of early humans. And even though we've evolved, our biases have not—we still tend to follow the pack. Social media sites like Reddit and Twitter can exacerbate this impulse, as evidenced by the meme-stock frenzy of 2021, in which stocks such as GameStop's hit new highs not because of fundamentals but because of hype on social media.
- Loss aversion: Losing is not only painful; it's twice as painful as a commensurate gain is pleasurable.1 That's one reason we're tempted to sell in the midst of a market sell-off—even when we know that doing so will lock in those losses.
- Recency bias: Like herd mentality, recency bias developed to help safeguard our ancient ancestors. After all, it made sense that a lion encountered last week could still be on the prowl. Market dangers don't work that way, but we still overweight the possibility that recent events are likely to be repeated.
"Herd mentality, loss aversion, and recency bias are always a risk for investors, but they've become even more prevalent thanks to social media and the recent volatility in the markets," Omar says. "Not even the most seasoned investor is immune to such impulses—but that doesn't mean you must be entirely at their mercy, either."
To help counter these instincts, Omar says it's best to be disciplined and limit your consumption of financial news and social media during periods of extreme volatility. "Long-term investors should be very methodical in how they navigate short-term 'noise,' focusing their efforts on ways to reaffirm their long-term goals," he says.
Likewise, take your time when making decisions, especially during uncertain periods. "If the move feels like it can't wait, you're not thinking long term," Omar says. "Scheduling time to talk with your financial advisor anytime you're considering significant changes can also act as a kind of natural brake."
1Ravi Dhar and Ning Zhu, "Up Close and Personal: An Individual Level Analysis of the Disposition Effect," Yale International Center for Finance, 08/2002.
The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.
All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.
Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.
All corporate names are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security.
Investing involves risk, including loss of principal.
Schwab Asset Management is the dba name for Charles Schwab Investment Management, Inc. Schwab Asset Management is a subsidiary of The Charles Schwab Corporation.0822-2EWB