I like to keep up on the latest in the behavioral finance literature, and a recent paper by a collaborator of mine – Martin Weber, one of the biggest names in behavioral finance – caught my eye. He finds that many individual investors reacted in a mix of good and bad ways to the financial crisis.
- They reduced their exposure to active managers…
- By leaving the market altogether (“despite strong tax incentives to remain invested in equities”).
- Or increasing their exposure to concentrated equity positions they manage themselves.
While the first point is good (reduced use of actively managed funds), the second two are really bad!
The first point speaks to “a loss of trust in financial intermediation prompting some investors to abandon the stock market altogether and the remaining investors to take on more idiosyncratic risk, on average.”
While I’d definitely say avoiding active management costs and under-performance is key, selling after a fall in prices is precisely the wrong behavior! The more you try to actively time the market, the lower your returns will be.
Equally worrying is that they moved to holding concentrated equity positions themselves. If the average professional manager can’t outperform the index in his full-time job, what makes these individuals think they can do it in their spare time?
Perhaps it’s just because they don’t have Betterment accounts. Our analysis indicates that only a small minority of Betterment clients sell or go defensive after a fall in value. Our site is built to encourage optimal behaviors like rebalancing and staying the course, and makes it easy to not get fearful when the markets are choppy.