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Resist behavioral biases when markets dip

Apr 22, 2020
Empower Insights

Why you shouldn’t go with your gut when the future seems uncertain

Humans rely on mental shortcuts to make decisions. It’s a useful strategy: The shortcuts mean we don’t have to consider every single bit of information every time we make a decision. However, those shortcuts, which humans developed to deal with life-or-death decisions, don’t always lead us to make rational choices, especially when it comes to money — or times of stress.

A recent survey by Empower Retirement shows that employees are concerned about how COVID-19 might impact their finances, and specifically their retirement savings.1 In this period of uncertainty, behavioral biases — those mental shortcuts that can lead us astray — may kick in. And that could have negative consequences — say, if you abandon your financial plans for some short-term relief that ultimately puts your long-term savings goals at risk.

It’s helpful to understand behavioral biases so you can work to overcome them. Here are two that are particularly relevant these days:

Loss aversion

Humans are hard-wired to recoil from negative outcomes — a tendency known as loss aversion. That’s why we feel the pain of losses more deeply than the pleasure of gains. Loss aversion explains why 15% of the employees we surveyed have shifted their investments to less risky vehicles since the COVID-19 crisis began: Staying invested simply felt too painful in the short term.1

However, changing your long-term plan based on recent market events is often a bad idea. Investors who sell stocks when they’re down will lock in their losses — and miss out on potential gains when the market recovers. A financial professional can help with financial decision-making during these uncertain times.

Our survey shows that 53% of employees aren’t looking at their accounts right now.1 They have the right idea. You can help yourself refrain from fear-based decisions simply by checking your account balance less frequently.

53% of employees aren't looking at their accounts right now

Recency bias

What’s happening now — the way the market looks, or the way we feel, for example — is a powerful influencer. The feelings or events of the present can make us forget what’s happened over the course of history. This may lead some to take action because they can’t imagine a different reality in the future. That tendency to over-value new information is known as recency bias.

As the world reacts to a pandemic, it’s easy to feel uncertain about the future. More than half of those surveyed are worried about how the pandemic will affect their retirement savings. They’re also concerned about a potential recession and market volatility.

But it’s important to remember events beyond the last few months. After every previous bear market, the market has gone on to recoup its losses — and then some. So when recent market conditions make you feel unsettled, look to history for a reminder of why sticking to your long-term plan is a smart strategy.

Stay the course through tough times

It can be difficult to remain level-headed during times of stress. In fact, the urge to take action when we sense danger is part of human nature. But when it comes to your finances, it’s critical to resist making rash decisions that are based on gut reactions. Instead, take a deep breath and remember: You’re in it for the long haul.

 

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1Empower Institute, "From Confidence to Concern: America's financial outlook in the face of a pandemic," March 2020.

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