Over time, I have come to believe that the reason behind such behaviour is primarily psychological. When stock markets are down, many investors are dissatisfied with their manager, but they are hesitant to make the jump to another manager, at least until the value of their portfolio has rebounded to what it was.
In my opinion, some psychological biases are behind this apparent investor paralysis.
The first is that of entrenchment. This bias occurs when our decision-making is strongly influenced by information that we received at the beginning of our decision-making process. For example, I can easily imagine that many investors are reluctant to change managers when the value of their portfolio is lower than it was at the start of their co-operation. Perhaps they also have in mind the value of their portfolio as of December 31, 2021. Think about this scenario: your portfolio was at the all-time high of $1.0 million as of December 31st and is now worth $875,000. Will you wait a while longer for the value to approach $1 million before changing managers?
The second bias is probably associated with our aversion to losses. Studies show that the psychological pain associated with losses is twice as great as the pleasure associated with an equivalent gain. Thus, a loss of, say, $1,000 hurts twice as much as the pleasure from a $1,000 gain. But in the minds of many investors, a loss isn’t really a loss until they sell or transfer their portfolio to another manager.
This is a good example where one could make an irrational decision based on psychological biases.
In my book, Avantage Bourse, which has just been published, I devote an entire section to the various psychological biases that affect the performance of investors. In fact, I identified at least 35 such biases.
But all is not lost: there are tricks to counter psychological biases. The first is to fully understand that such biases exist and that they are very likely to influence one’s decisions.
In our example case, an investor should decide based on facts, not emotions. The decision should be based on a single question: will a change in manager improve my potential long-term returns?
I will be taking time off from blogging during the holiday season and will be back on January 6, 2023. So, I’d like to wish you Happy Holidays and a Happy New Year 2023!
you for reading my blogs. Do not hesitate to contact me with your comments, questions, or suggestions. Your e-mails are often a source of inspiration for future blogs.
If you want to learn more about the investment philosophy that we advocate, may I suggest my book, Avantage Bourse? It is now available by clicking on this link.
Thank you and good investing success in the long term!
