Research shows that when the stock market increases, people invest more money, and when the market falls, they pull their money out. This is totally irrational behavior, but unfortunately, retail investors are influenced to buy stocks when they’re in the news, and this speculation often pushes the stock price higher. We saw this behavior when retail investors jumped on the Gamestop bandwagon earlier this year and drove the price through the roof, only to watch it soon tumble. It’s likely not too surprising that Investopedia reports that retail investors have underperformed the S&P 500 by 11% since mid-February this year. Jumping on stock trends can lead to costly mistakes because the price is often artificially inflated. This activity is like going to the store to buy a lawn mower at the most expensive price, only to return the mower when it goes on sale. Make it make sense.
Reacting to news
Economists want to believe we’re rational when it comes to our wallet, but that just isn’t the case. Humans are emotional creatures, and behavioral finance is the body of work which covers these concepts and how they apply to our daily lives. We’ve touched on this topic several times which you can read more about here, here and here.
When it comes to investing, often the best thing to do is nothing. Rather than set it & forget it, too many modern retail investors trade based on media and media personalities. Berkeley researchers found that as a group, seemingly novice investors trade “actively, speculatively, and to their detriment. This investor group makes systematic, not random, buying and selling decisions.” Yikes. Now take into account the context of this chart from the Investopedia article mentioned above:
Suffice to say, a lot of activity has been happening.
Thinking they have a crystal ball
Overestimating our talents and abilities is very human. For example, 75% of Americans consider themselves to be financially savvy, yet 74% of 13-21 year olds weren’t taught about money. Overconfidence is an affliction that plagues all of us, not just investors. Well, sometimes especially investors! 😜 The Berkeley researchers mentioned above found that many investors “assume that the recent past is indicative of what is to come.” Looking at past data and information combined with self-assuredness makes many retail investors believe themselves capable of predicting future returns. Be careful, that lazy thinking could be a recipe for disaster!