During bull markets, investors have a concise memory of previous bear markets. Such is why, throughout history, cycles repeat as lessons must get learned and relearned.
Such was the topic of a recent article fromARS Technica:
“There’s extensive academic literature on the risks faced by investors who are overly confident of their ability to beat the market. They tend to trade more often, even if they’re losing money doing so. They take on too much debt and don’t diversify their holdings. When the market makes a sudden lurch, they tend to overreact to it. Yet, despite all that evidence, there’s no hard data on what makes investors overconfident in the first place.”
Behavioral finance has spent years digging into investor psychology and the repeated behaviors through market cycles. As you can probably surmise, investors develop few “good” behaviors and are the biggest reason for underperformance over time.
“Behavioral biases that lead to poor investment decision-making is the single largest contributor to underperformance over time. Dalbar defined nine of the irrational investment behavior biases specifically:”
- Loss Aversion
- Narrow Framing
- Mental Accounting
- Lack of Diversification
- Media Response
During bull market advances, “herding,” “lack of diversification,” and “anchoring” are the most common problems. These behaviors tend to function together and compound investor mistakes. As noted previously:
“Bull markets hide investment mistakes. Bear markets expose them.”