Psychology plays a vital role in not just the attitude with which we live our lives, but is also instrumental in driving investment decisions. It represents regularities in the way people process and act on information.
While the decision taken by individuals are based on biases that control their economic behaviour, they often tend to behave irrationally with their minds clouded with fear and anxiety, especially during a financial turmoil.
Risk is no doubt an essential component in taking a financial decision, be it taking a loan or buying shares of a new company looking at its potential. And, investors are often influenced by cognitive biases in forming their perception of risk and return on an asset, that can affect the way rational markets operate.
James Montier has rightly quoted, “Success in an investment does not associate with IQ once you reach above the level of 100. If you have ordinary intelligence, you just need a temper to regulate the desire that gets other people into danger in investing.”
The Asian market crisis, hedge fund crisis 1998, the global financial crisis of 2008, followed by a great recession shows how extreme behaviour and irrational incentives in the financial system can lead to a disaster.
During uncertain times, decision making happens to be more skewed, analysis is less idyllic, and the bid to take action based on the wisdom and preferences of the individuals becomes more relevant, leading them to take biased decisions.
Investors’ Behaviour During Coronavirus
Amidst strict lockdowns and self-quarantine worldwide, COVID-19 has brought stock markets to their lowest levels, with investors left wrestling with their own minds for their investment plans.
People are sensitive more to losses than to gains. The damage that they will experience is more in the minds of some people while making an investment decision during times of uncertainty.
They tend to avoid risky decisions that have significant economic consequences such as buying, cars, houses etc. They take less credit and save more. Risk avoiders need a higher probability of gains to tolerate exposure to failure.
At present, stock markets are extremely volatile characterised by panic selling and people rushing to safe haven. With asset prices plunging to record lows and massive selloffs during the past month, investors are gripped with fears of the worst.
People tend to make decisions to choose the right movie, restaurant, phone by confiding in the crowd behaviour, which turns out to work well for them.
It is usual to follow the crowd when we are not sure about something. Consequently, our minds are driven towards taking shortcuts rather than solving complex problems in front of us. Hence, if investors lack confidence and optimism in making decisions at the times of market volatility, they will tend to follow the herd.
It is physically uncomfortable and emotionally draining to go against the crowd especially during tough market situations. Thus, investors are more prone to this behaviour at present.
Relying too much on social media
Many investors base their decisions on the news they watch or information they receive on their social media accounts. At a time when the global economy is suffering from the impact of the virus, it is a normal human tendency to have a look at the number of deaths and infected people from the virus globally. Since the number is too high, it can scare the investors if they look at the statistics too frequently.
Social media can make you believe misleading information and stop you from making a wise decision about the event. A lot of investors tend to believe fake news and look at the wrong statistics to assess the situation.
Behavioral Tips For Investors Amid Lockdown
While investors are trying to access and reframe their portfolio during heightened market uncertainty, they may consider below tips to navigate through this tough environment.
Guard yourself against emotions
Investors with a cool mind are often able to make better investment decisions than the ones panicking.
When asset prices have plummeted, buying assets from individuals who are in fear is similar to buying them on sale. Investors who are patient await prices to return to their projected levels. History, ranging from world war 2 to 9/11 attack, markets have always bounced back after hitting deep lows.
You must have patience, discipline and adequate wealth in liquid assets available to make profits in a crisis. Replacing panic with positive emotions can help investors in taking a wise investment decision.
Confidence in your ability
A strong sense of optimism and confidence along with well-diversified investment mix can help you in making much better investment decisions. A behaviour of belief on making a profitable investment on your own can help you in making one.
However, people must be vary of over-confidence. They might tend to believe that their abilities are above average; their knowledge is far superior to others or might be extremely optimistic about the future relying on their own judgements of the past and present. Overconfidence can lead to underestimating actual risks and not processing all the relevant information.
Don’t follow the herd behaviour
Selling in a falling market can make you miss out on the recovery that follows. When investors make their own assessments to choose securities, it helps in efficient price discovery. However, if they tend to follow the herd, they will always tend to select the same investments selected by others losing all the diversity.
Look at Verified sources to form opinions
You must rely on trusted sources like the Centre for Disease Control and World Health Organisation (WHO) for any information to form your opinions and assess the intensity of the health and financial crisis.
People are susceptible to panic and act irrationally when an economic crisis hits. With a patient and calm mind, market participants can make much better decisions on their investments taking future conditions into account.