During Volatile Times Beware of Behavioral Biases

Key Takeaways   

• Anchoring, confirmation bias, and loss aversion are common behavioral biases that can derail financial decision-making.  

• Investors often fixate on previous high values instead of looking at the big picture. Research shows losses hurt people more than gains thrill them.  

• Working with an advisor can help you avoid making unwise, emotionally driven decisions that derail your plan.  

During periods of heightened market volatility and economic uncertainty, we tend to see a spike in self-destructive investor behavior. These actions are frequently driven by behavioral biases that cloud our judgment when it comes to investing, saving, and spending. 

The field of behavioral finance has identified over a dozen common biases that can derail your plan if left unchecked. Today I’d like to discuss three of the most common ones -- Anchoring, Confirmation Bias and Loss Aversion -- and how you can cope with them.  

1. Anchoring is about fixating on a specific number, such as the highest amount your retirement account ever reached, or the all-time high for a stock you own, or the recent high for the Dow Jones Industrial Average. Nothing in the world of finance goes up forever without taking an occasional pause. You haven’t “lost” money when investments fall from a recent high-water mark. You have simply given back a small portion of the gains you have racked up over time by being a disciplined investor.  

When clients express concern about how much they’ve lost since the market peak, we shift the focus away from short-term fluctuations and instead evaluate whether they remain on track to achieve their long-term financial goals. In most cases, no changes are necessary, and that perspective often brings clarity and reassurance. 

2. Confirmation Bias occurs when people only seek out news that reaffirms what they already believe. If they're concerned about what's going on in the market, they gravitate toward doom-and-gloom pundits who are warning about another steep drop in the markets and that they better go to cash or buy gold “before the world ends.” When we sense a client succumbing to confirmation bias, we reframe the narrative. First, we tell them to take a break from the news and then realize that there will always be temporary blips in the market like we’re having today. It’s not going to be the end of the world. The market will recover as it has always done through every crisis.   

Confirmation bias occurs on the plus side as well. Remember how all the early investors in Bitcoin were feeling pretty confident as it racked up double-digit and triple-digit gains every year. They told themselves it was a “can’t miss” investment and subscribed to all the pro-Bitcoin newsletters and podcasts that supported their view and ignored the other analysts and news sources that were more skeptical about crypto. This prevented them from taking some chips off the table when it reached as high $110,000 per coin. By September of 2024 it had fallen to a little over $52,000 per coin and even after rallying back to $110,000 when President Trump moved back into the White House but now trades around $80,000. That’s a lot of stomach-churning volatility to endure without taking some chips off the table.  

3. Loss Aversion. Research shows that humans feel the pain of a loss much more significantly than they feel the joy of a gain. Loss aversion occurs in sports and gambling, not just in investing. Since people tend to be more afraid of losing money than missing out on home runs, whenever there's a downturn in the market, they convince themselves the slide is going to continue indefinitely. Without having a skilled advisor by their side, they’ll be tempted to cash out of stocks and put their money into something “safe” like CDs or Treasury bills, just so they can take some risk off the table. But when the market starts to rebound, they usually miss out on the recovery because they have too much cash on the sidelines that they can’t put back to work fast enough.  

We help clients cope with loss aversion by helping them set up an asset allocation that aligns with their tolerance for risk. We do that through global diversification of their stocks and by investing in a broad basket of bonds that helps dampen volatility. During very strong bull markets like we saw in 2023 and 2024, some clients were disappointed that their returns didn’t match those of broad stock market indexes like the S&P 500. But now that the tide has turned, you can see how calm and reassured they are knowing that their portfolio is down only slightly when the average stock market investor is down double-digits. That’s when the value of a well-diversified strategy truly shines.  

By the way, don’t beat yourself up if you’re susceptible to the behavioral biases above. They’ve been part of human DNA since the time of the cave people. During times of stress or danger, our brain tells us to run away and find safety if we want to stay alive. Precipitous market meltdowns can trigger the same kind of fight or flight response in modern humans. They’re a threat to our sense of wellbeing.   Again, one of the biggest benefits of working with a skilled advisor is that he or she can prevent you from succumbing to these ingrained behaviors that if left unchecked, can greatly erode your wealth.   

Conclusion 

 If you or someone close to you needs to review your plan during these unsettling times. Don’t hesitate to reach out. We are happy to help.  

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RYAN A. DUNN, CFP®, is a Wealth Manager at Novi Wealth