Buy low and sell high! Although this is very easy to say, it is much harder to implement in practice. For the most part, investors are rational and make prudent decisions from an investment standpoint. However, when put in traumatic and volatile situations rational investors often make decisions based on emotion. There is no better example than in 2008, when many investors made emotional decisions regarding their retirement savings by selling much of their investments only to watch the stock market come roaring back for the next 7 years.
Behavioral Finance is a relatively new field that seeks to combine behavioral and psychological theory with conventional economics and finance to provide explanations for why people make irrational financial decisions. Although this may sound daunting it is easier to explain with graphs like the one below, which we will review with you to have a basic understanding. The point of the exercise is help you alleviate stressful market environments when they inevitably occur.
This graph shows the emotional feelings investors typically have during periods of increased volatility. As the market goes up investors gain confidence and a euphoric feeling, and as the market declines so does their confidence leading to panic. We stress education so that our clients are properly invested according to their level of risk.