By Anirban Bose
Global market volatility has been a roller coaster in the last few months, but most recently we've seen the Dow Jones Industrial Average jump and S&P repeatedly hit new records. It's a stark contrast to August's selloff across the U.S., Europe and Asia. Today we're also seeing inflation show signs of cooling as the Fed slowly starts to cut rates. We're also seeing the new presidential administration and coming policy changes take shape as the inauguration gets closer.
With so many market factors moving at once, it underscores the impact that investor emotions have on market dynamics and highlights how swiftly sentiment can shift and influence outcomes. Earlier this year we saw a clear example of how emotions and fads sway investors. Two meme stocks, GameStop $(GME)$ and AMC Entertainment $(AMC)$, lured retail investors back to social media, where they engaged in conversations about whether to buy, sell, or hold, leading to another pop of trading fervor.
It can be exhilarating pulling the trigger on a stock pick and seeing where it lands. But that same uncertainty has become a defining factor of investor behavior.
The age of investor influencers. Not long ago, it would be absurd to imagine placing a big position on a stock favored by someone on social media. Or investors being so skittish from reports of a lagging economy (based on just one month of data), that they cut their losses in droves despite assurances that a recession is likely not on the horizon.
There are financial psychology terms to explain all this behavior. For example, anchoring bias, which partly drove Bitcoin's 2021 boom and bust as investors relied heavily on initial information, fixating on the cryptocurrency's past performance to determine its future trajectory.
Investors acting irrationally is not new -- and neither is investment bias. The real lesson is that investors often base financial decisions on feelings instead of fundamentals, like a company's underlying track record.
Humans are emotional creatures. No one is immune from bias. Even though high-net-worth individuals (HNWIs) may be accustomed to making shrewd investment decisions, new Capgemini data show that this group also admits biases impact their decision-making. Their judgment is clouded by significant life events like marriage, divorce, and retirement. Add geopolitical uncertainty and volatile market conditions to the mix, and it's easy to understand how even smart investors might make a rash decision that could end up negatively impacting their long-term financial goals.
Biases span the spectrum of the investing universe. For instance, 65% of HNWIs recently surveyed said they're susceptible to confirmation bias, seeking information from sources that already align with their views. At the same time, HNWIs reported financial biases such as risk aversion (45%), meaning they're too conservative to grab potential opportunities. Others are swayed by the disposition effect (45%), where they hold on to underperforming investments for an extended period.
Clients crave guidance to not yield to biases. To reduce market losses because of their clouded decision-making, most HNWIs seek outside investment counsel. In fact, HNWIs have doubled the number of relationships they have with wealth management firms: from three in 2020 to six in 2023. This signals an industry that is struggling to deliver the expected range and quality of services demanded by this segment.
Just as the wealthiest expect their financial advisors to proactively manage their portfolio, offer real-time updates and investment advice based on their objectives, they also expect data-driven rationales in a frequently irrational market. Yet, the numbers show only 13% of advisors connect with clients as soon as market volatility hits or a significant life update disrupts the status quo. This points to deeper and wider problems at the core. We need to do something about this.
Here is where we witness the immense impact of behavioral finance, going beyond traditional investor risk assessments. By capturing deep insight into a client's risk tolerance, stress response and decision-making style, advisors can be better armed to alleviate client anxiety and prepare a more rational response for the journey ahead.
A complete psychographic profile of clients must rely on behavioral data collected from alternative sources. This is where advanced technologies might help. AI-driven technologies can analyze what's called unstructured data -- think influential news media or analyst reports, Reddit threads and more -- which is highly valuable information that can feed bias.
But these AI-powered tools need to do more than capture and distill potentially biased information influencing market and client behavior. Advisors must leverage these tools to match a client's potential bias, whether that's hype in an individual stock or sector, against the client's portfolio objectives and, most important, the business fundamentals of an investment. For equities, this includes standard assessments of a company's quarterly earnings, comparative P/E ratios, analyst sentiment, and more.
Ultimately, the measuring stick to assess the impact of these tools will be the advisor's ability to anticipate client responses to life or market events at the right time, every time.
Bottom line: financial institutions cannot underestimate the challenge of human nature in staying the course. Emotions and mental shortcuts can cloud judgment. This is why it has never been more important to gain a strong understanding behind the mind-set of the investor. The consequences can be devastating for those who are blinded by bias.
Anirban Bose is CEO of the Americas Strategic Business Unit at Capgemini. He previously served as head of the firms financial services strategic business unit and was also a member of the group executive board and oversaw the Asia Pacific strategic business unit. He graduated from the Indian Institute of Technology of Varanasi and holds an M.B.A. in Finance from the University of Chicago.
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
November 20, 2024 16:01 ET (21:01 GMT)
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