The effect of the coronavirus pandemic on investor behaviour
It would be nice if investors and markets moved solely on the basis of fundamentals and economic and financial analysis of businesses. But at times, investors appear to lack self-control, act irrationally, and make decisions based more on personal biases than facts.
The study of such psychological influences on investors and, by extension, markets, is called behavioural finance.
There are four main key concepts to behavioural finance.
Mental accounting – the propensity to allocate money for specific purposes
Herd behaviour – the habit of people to imitate the financial behaviour of a majority
Anchoring – the attachment of a spending level to an easy reference, like spending more money for a popular brand of anything.
High self-rating – the tendency of individuals to rank themselves higher than an average individual.
The coronavirus pandemic has caused a lot of panic worldwide which has led to a world stock market crash. Many investors sold shares after prices crashed. This is an example of herd behaviour. Ironically when prices have fallen a great deal this is in fact potentially a far better time to buy rather than sell.
Some studies have shown that the fear of loss of money is equivalent to the fear of death to people psychologically. Of course at the moment, during the coronavirus lockdown, people are fearful of both death and the loss of money.
I am proud to say that many of our clients have taken this opportunity to buy rather than sell shares. Many years of educating our clients have finally paid off. They have treated it as a buying opportunity like a Black Friday or New Year Sales.* The following slide persuaded a number of our clients to drip feed money into their investments over a three months period on the basis that stock markets are likely to fall in the coming months.
At the time of writing on 7 May, world stock markets appear to be on the precipice of a large fall following a very strong rally. We seem to be at the point of the graph entitled “Return to normal” just before “fear” sets in. However, once they reach a new low the ensuing recovery is likely to be very strong. Of course this is just my opinion but historical precedent is in my favour! The graph depicts a typical economic and stock market cycle and investors’ behaviour.
*The value of investments and the income derived from the may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs’ practice. Levels and bases of tax relief are subject to change.