What you felt: If you felt deeply pessimistic about your investments in the spring, you showed signs of what behavioral economists call “extrapolation bias” even after the market rebounded. But guess what. If you decided to be a day trader back in April when the stock market rebounded and you are excited about the gains made, you are now under the same effect.
Extrapolation bias occurs when people attach extra weight to current events, assuming that those events will continue. Stefano Giglio, professor of finance at the Yale School of Management, conducted surveys among investors at the start of the pandemic. In February, when the coronavirus was just beginning to spread in the US, investors expected the S&P 500 to return 6 percent this year. By mid-March, investors were expecting a return of only 1 percent, and that expectation remained until April – although stocks bounced back.
“People across the board have become more pessimistic,” said Professor Giglio.
However, new investors with little experience investing turned out to be like hedge fund stars when they started investing in the spring, said Maguire of Boston Private. Shares have generally been higher since late March, although they have been more troubled lately. However, if these investors feel that their returns are the result of immense skill and not good market timing, they could suffer badly from a market correction.
“I fully intend for people to keep doing this, but it could end badly for them,” said Maguire. “It is a behavior change explained by the expectation of gains that triggers a dopamine response in the brain.”
Another reason for fear of investing is the distortion of availability. The more information is repeated, the more you believe that information is true in the long run – without investigating other potential outcomes.
With the pandemic, many people couldn’t help but learn lessons from previous pandemics, said Michael Liersch, director of advice and planning for Wells Fargo’s wealth and investment management division. But, he said, this way of thinking doesn’t work in the long run, even if it makes us feel better right now.