What Do Investors (Irrationally) Fear?

The CFA Institute published its annual sentiment report this week. It surveys individual and institutional investors to determine what they are anxious about.

You might be surprised to learn that about one-in-three is greatly concerned about another 2008-09 type financial crisis:

Investors revealed a growing anxiety about the state of global finance. Almost one-third of investors feel that another financial crisis is likely within the next three years (33 percent of retail investors/29 percent of institutional investors).

In some countries, such as India (59 percent) and France (46 percent), the fear factor was even greater.

Just as every general fights the last war, investors, too, fear what just happened. Rarely (if ever) are they concerned about the unknowns that might be ahead. We even discussed this last year in “what just happened versus what happens next.” It is simply part of investor psychology.

Why is this? The “Recency Effect” affects investors even more than it does generals and others. Loss aversion is based upon how much more painfully and deeply investors experience a financial decline versus the more modest impact of the positive emotions associated with a gain. As we learned from Daniel Kahneman and Amos Tversky, it’s not that we don’t like to make money in the markets — of course, we do — it’s just that the pain of loss is twice as strong as the pleasure of gains.

 

Continues here: Past Trauma Blinds Investors to Present Danger


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