The intricacies of investor psychology shed light on what people are doing to miss out on long-term opportunities—and on how advisors can help them overcome those behavioral hurdles, according to a recent report from Franklin Templeton Investments.
Behavioral phenomena can have a negative impact on investor psychology, says Franklin Templeton in a wide-ranging “thought leadership” comment, “2020 Vision: Time to Take Stock,” on its public website.
Investors experienced loss during the 2008-2009 financial market crisis, and much of their negative perceptions of market growth stems from that time. As a result, many investors are afraid of experiencing the same sort of loss now.
With the help of Predictably Irrational author and behavioral economist Dan Ariely (left), Franklin Templeton pinpoints three behavioral reasons why investors may be missing out on opportunities for the long term:
1) Loss aversion. The fear of losing even more after suffering a loss paralyzes investors and prevents them from taking risks. This can cause investors to become overweight in perceived “safe” investments, according to Franklin Templeton. Unfortunately, this fear of any type of risk can lead to loss of potential gain.
Franklin Templeton Investments’ Beyond Bulls & Bears editorial team spoke to Dan Ariely, James B. Duke Professor of Psychology and Behavioral Economics at Duke University, who has studied people’s often irrational behaviors and actions, including the concept of loss aversion.
“He shared some insights with us about his experiments and findings about how we experience the pain of loss, and how it often overrides the reward felt from gain,” Beyond Bulls & Bears reports. “People hate losing much more than they enjoy winning. How happy are investors when they make 3% on their investments and how miserable are they when they lose 3%? There is a tremendous asymmetry.”
2) Availability bias. In a comment titled “When Do You Ignore Your Gut?,” Beyond Bulls & Bears describes how a person’s perceptions are shaped by environment and experience. For example, Franklin Templeton’s Global Investor Sentiment Survey found that investors currently believe the market was either down or flat in 2011 when in reality the S&P 500 saw gains.