In 2017, the Nobel Prize in Economics was awarded to the American Richard Thaler, Professor of Economics at the University of Chicago. His work focused on the psychological mechanisms that influence consumer and investor market behavior.
They demonstrated that human beings tend to simplify their financial decision-making by focusing on the short-term effect of each decision, rather than on the overall long-term effect.
The vertical scale is a satisfaction index. The horizontal index is for gains and losses. When the investor earns $1,000, his satisfaction index is at 100. When he loses $1,000, it's at -210, more than double. For the satisfaction index, we could have taken 50 or 200 when he earns $1,000. It serves only to compare satisfaction or dissatisfaction.
This behavioral reality can lead to disastrous decisions in times of high volatility. Investors struggle to hold on to their investments during these periods.
Today, managing emotions is essential.
Another important lesson from behavioral finance is that "investors chase the market" or, if you prefer, "market-timing". Periodic investment of fixed sums is more profitable than synchronization.
The small steps strategy
An efficient way to "beat" periods of volatility is to invest regularly. This method is known as "dollar-cost averaging".
Behavioral finance teaches us above all that human beings are profoundly averse to risk. Investors tend to react to losses according to a rule of three, illustrated by the following graph.
As Richard Thaler's work has shown us, we have two systems of thought.
System 1 or rapid thinking: fast, automatic, intuitive and emotional. The default option for information processing.
System 2 or slow thinking: slow, intentional, more deductive and logical. As this system requires deliberate effort, it is often preferred to system 1.
As market volatility plays on our emotional thinking, we're all at risk of making premature and catastrophic decisions.
Your advisor, on the other hand, looks at the situation with his or her rational, unemotional System 2.
Be patient. Trust the strategies we've developed together.
When in doubt, contact us immediately.