Investor Behavior During the COVID Sell-off

Updated: Sep 14, 2021

Investors rarely get meaningful feedback in a bull market. In fact, you can get misleading feedback. For example, let's say an investor randomly buys an investment which then goes up in value. They might be thinking, "Hey, this is easy. This must be a good investment!"

The investor doesn't have a process, risk management strategy, or a framework to make investment decisions. The investor does have a new found confidence and false sense of security. Our new savant is now their own worst enemy.

"What gets us into trouble is not what we don't know. It's what we know for sure that just ain't so." - Mark Twain

The golden decade of 2010 provided a ton of misleading feedback, and runaway gains with very little stress for investors. Complacency set in. Folks that had no business taking risk got lulled into a false sense that markets only go up.

Humans are prone to recency bias. We overvalue what just happened and project the outcome into the future. If the market was up the past six months, the market should be up the next six months. If the market craters by 30% in 30 days, the rest of the year should be really bad.

We see this in data we collect from our investors. We send out a simple question every quarter...

During difficult market periods (Spring 2020), sentiment was negative. During periods where the market was up (Q2 2020), sentiment was positive. This is recency bias in action.

The set-up from easy gains to once-in-a-lifetime market/economic turmoil in early 2020, sprinkled with some recency bias, makes a dangerous cocktail. The fallout left many investors panicked and unprepared.

Here's what we observed through our many interactions with investors...

  • People still crave a good forecast. They have a belief that someone, somewhere knows what is going to happen next. Humans seek the soothing feeling of certainty, despite overwhelming evidence that forecasting is utterly worthless. Take a good look at 2020 forecasts (published last 2019), it should make you never take another forecast piece seriously.

  • There is a belief that portfolio management is reactionary. In other words, wait until the market goes down 30+% and then make a bunch of changes.

  • If you have an extreme disposition, either positive or negative, it's amplified during times of uncertainty. The tendency is to seek out information or opinions that confirm your beliefs, rather than challenge them.

  • Without fail, people will make hugely impactful decisions well outside their scope of expertise. The panic-seller and the market-timer have had a rough go of it. Just as quickly as things cratered, the bounce back was just as ferocious. Following your gut or making an emotionally charged decision probably didn't end well.

  • The investor who is conservatively positioned and waiting for a pull back, with a plan to get more aggressive on the dip, will likely have trouble pulling the trigger. We often say the time to get more aggressive is when it feels the worst. It's easier said than done.

Investors who exhibited the best behavior, thus had the best outcomes, did one amazingly simple thing:

They were candid and honest about their ability to take on risk.

That's it. No magic insight. No forecast. No ego.

A few examples...

Bertha was conservative. Bertha let us know she was conservative. We built a conservative portfolio. She didn’t blink twice during the sell-off.

This works for aggressive clients too.

Randy was risk seeking and aggressive. Randy let us know he was aggressive. We built an aggressive portfolio. He knew negative outcomes, sometimes extreme, are part of being an all equity investor.

Cletus thought he was aggressive. Cletus was really conservative. He found out his true risk tolerance during the sell-off. Cletus sold, locking in losses and has been skittish about getting reinvested, thus missing out on a huge rally.

This is an avoidable, but all too common outcome. One can avoid the self sabotage by being true to one's risk profile and building the right portfolio. Here's how you can get started...

Using Technology to Frame your Risk Profile

Recognizing your Blind Spots

Framing Acceptable Range of Investment Outcomes (90 second exercise that will help you build a portfolio that mirrors how you feel about risk.)

Self assessment and inward reflection are part of being a successful investor. We do the same thing with our own decision-making process. Investing is hard, especially when the losses are piling up. Mistakes will be made. What's important are the lessons we take from them.

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