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It was 2008 and James, a newly minted Ivy League MBA had recently joined David Lewis’s team, at a global bank on Wall Street. The markets had been sliding since late 2007 and the Bear market was gaining momentum - downwards. It was being called the global financial crisis.

James lamented, “I finally made it to Wall Street and the whole industry is melting down. I picked a terrible time to be a banker.” David said, “James, you picked the best time because the markets will recover and inevitably go through another bear market some time in the future. You can then remind people about what happened in the global financial crisis and hopefully help them make better decisions the next time.”

We can remember people predicting that the markets would keep dropping until they hit zero. It was a scary time and some people were panicking and liquidating everything. Those who sold everything lost the most. Of course, the markets did recover and starting in February 2009, became the longest bull market in history, lasting up to March 2020.

The world is grappling now with the economic fallout of a global pandemic. Those on Wall Street might be feeling much as James did in 2008. If well-trained professionals are displaying irrationality in the face of volatility, imagine the mindset of the average investor. In order to help investors, advisors must overcome any temptation to show fear, panic, or the pessimism that James showed. Despite our best efforts to be rational decision-makers, we often are predictably irrational. In the 1950s, Herbert Simon described people as boundedly rational - we try to be rational but only have so much mental energy and time, so we often fail. Kahneman and Tversky’s work in the 1970s showed that our reliance on heuristics in the face of these time and energy constraints, can lead to predictable biases.

How can we preserve rationality in our ranks, and just as critically, amongst investors, in these trying times? Understanding the common errors made both by institutional and individual investors when volatility reigns can come through understanding the science of human behavior.

A number of cognitive biases contribute to our collective inability to let history guide us. Looking back to the stock market crash of 1928, or the financial crisis of 2008, we know that things bounce back. Confirmation bias compels us to find information that supports our view that things are crumbling -- remember, there were people in 2008 predicting that the Dow, Nasdaq and S&P 500 would go to zero. Representativeness bias leads to short-sighted decisions, sensitivity to momentary information, and a belief that current emotions, such as fear, will persist well into the future. People believe that what is currently happening is permanent and will continue even though we know markets eventually start rising again.

Relatedly, we see the bias of loss aversion taking root. People feel the pain of losses more acutely than pleasure from an equivalent gain, leading them to myopic viewpoints and frequent checking of accounts. But, loss aversion is not the end of our irrationality. As investors check their accounts, they are also plagued by the illusion of control bias, where we think we have agency and control in situations when in fact we do not. Further augmented by the overconfidence bias, many people try to make moves when they should really stand pat. These biases end up leading us to sell our portfolios in the face of downturns, to feel like we are taking action against volatility.

Behavioral economics not only pinpoints these biases, but it also provides directions for how to overcome them.

One solution is to get investors to listen to advice from experts. In a recent study by BEworks, we found that fewer people have an advisor and follow all of the advice (13%) than those who had no advisor or have an advisor and ignore their advice (21%). In the middle, the remainder have a financial advisor but only follow some of the advice.

To counter loss aversion, we can encourage investors to use mental accounting (Thaler, 1990). If people separate their money into a portion they need for short term emergencies and the rest of their money as being long term, and leave that long term money in the market knowing that it will eventually recover and earn back any losses, they can be less tempted to dump everything at an inopportune time. Another technique is long-term gain framing. Look at the markets over a 10 year period and the large drops we see daily look like small blips. One good piece of advice is to actively limit how frequently you look at your account.

To fight representativeness bias we can use explicit emotion priming (Blanchette 2007) where we acknowledge negative emotions and confront them. When emotions such as fear and anxiety are confronted and recognized as natural responses to stressful times, they lose their ability to hijack our thinking. Another technique is to envision your future self (Hirschfeld 2011) following your dream in the future. People who took a long term view in 2008 and stayed in the market are much better off than those who panicked and stuffed their money in their mattress. Thinking of the long term can remove the temptation to react to short-term information.

Countering the illusion of control can be done by explicitly recognizing and framing the losses of forgone gains when the market eventually turns, and we know people are averse to losses. If they move at the bottom, they will lose out on the eventual rise. Another way of countering the illusion of control is by priming self consistency. Remind people that they thought carefully when constructing their portfolio, and the portfolio may have done very well for years, and this leads them to pause before unwinding it all. We like to be self consistent so when we think of all of the careful thought that went into the portfolio, we are less likely to question our previous judgement and more likely to question our current panic.

One method to combat the overconfidence that many investors will exhibit, thinking they can make the right move when there is no right move, is with information accessibility. Ask investors to name top athletes, and they can surely easily come up with ten. Next, ask them to name people who consistently and successfully time the market by selling just before the crash and buying back in right at the bottom. They will have trouble naming any and in the long run, there are none.

In popular culture, Michael Burry, the lead character in the film The Big Short is seen as correctly timing and profiting from the subprime mortgage crisis but the film leaves out the fact that Burry liquidated his positions in 2008 and missed the gains that would have come if he had waited for the 2008 and 2009 government bailouts.

David Lewis, PhD, CFA, MBA, is the Chief Client Officer at BEworks. David has held numerous senior positions including Head of Technology, Head of Marketing, President, CEO, and Chairman of the Board, at global financial institutions including Barclays Wealth USA, UBS Bank USA, UBS Financial Services Americas, ING DIRECT USA, and Bank of Nova Scotia.

Kelly Peters, MBA, is the chief executive officer and cofounder of BEworks. She pioneered the BEworks Method, which is being applied at Global 1000 firms and in policy groups around the world. She held senior positions in strategy and innovation at Royal Bank of Canada, and Bank of Montreal, and several startups. Find her on Twitter and LinkedIn.

Dan Ariely, PhD, is the co-founder of BEworks; Professor of Psychology & Behavioral Economics, Duke University; and is recognized as a Top 50 Most Influential Thinkers (Bloomberg). Dan is also a three-time New York Times Best-selling Author, including Predictably Irrational.