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Why do retail investors make the decisions they do and what are the consequences? Well, the answers may all come down to behavioural finance.
This week Stockhead has been covering the extensive findings of ASIC retail investor research, which surveyed 1,053 Australian retail investors aged 18 and over who had directly traded in securities, derivatives or cryptocurrencies at least once since March 2020.
Among key findings of the research:
In our final part of our coverage we asked Deakin University behavioural finance academic and Morningstar analyst Erica Hall for her views on the research, and she was not surprised by many of the findings.
“Behavioural finance is trying to get to the heart of why people behave the way they do and the impact that behaviours have on our economic decision making,” Hall said.
She said 2002 Nobel Memorial Prize in Economic Sciences Daniel Kahneman brought to us the concept of system one and two thinking, which is showing through in the ASIC research.
“Essentially it takes a lot of effort to properly analyse and make decisions which Kahneman labelled system two thinking which is why we make mental shortcuts so we can spend most of our time in system one thinking which is automatic and requires little effort,” Hall said.
“Mark Zuckerberg wears grey T-shirts all the time, Steve jobs wore his black turtleneck and why do they do this? It’s an efficiency gain and a way to reduce the magnitude of decisions they have to make so they reduce superficial decisions to focus on the ones that matter – decision fatigue is real.”
The ASIC retail investor report found the most common asset class held by investors was Aussie shares at 73%. Hall said there is a well-known behavioural finance bias called home bias or familiarity bias where you stick with what is familiar to you.
“We recognise the brands on the ASX – the Big 4 banks, the large supermarkets and retailers,” she said.
“On the one hand investing into companies you know makes sense, as it takes time and effort to research new stocks and it is efficient to invest into local stocks familiar to you.”
However she said sticking to local companies that you know could have some unintended consequences.
“Lack of diversification is one – remember Australia makes up approximately 2-3% of the market capitalisation of the global stock market.”
The second most common asset class held by retail investors was cryptocurrency at 44%. Furthermore, a quarter of surveyed investors who had cryptocurrency indicated that it was the only investment they held.
So how do we explain the love affair with crypto?
“Well this is a prime example of FOMO – fear of missing out,” Hall said.
“Cryptocurrencies have had a meteoric rise in value, albeit now having also had quite a price correction, but during the massive price rises there were so many stories about people who have made substantial wealth via crypto investing.
“Who does not want to take part in earning of some easy money? Getting rich fast is an alluring concept.”
Hall said there is a behavioural bias known as herd mentality or the bandwagon effect, which occurs when investors follow the crowd rather than making their own decisions and undertaking their own research.
“Follow the bouncing ball and you too can make a lot of money, following the crowd makes us feel good.
“Going against the crowd makes us feel uncomfortable – market bubbles are an extreme outcome of herd mentality in action.”
Hall said herd mentality dovetails nicely into confirmation bias which occurs when you have a particular point of view and you seek out information that backs your viewpoint.
Social media and networking platforms (41% collectively) were a common source of information for retail investors. Commonly accessed social media sources for retail investors seeking investment information were YouTube, Facebook, podcasts and financial influencers.
“Social media feeds our confirmation basis because the algorithms they use keep on providing us with similar information that we have interacted with, therefore we don’t get exposed to alternative points of view. Rather, social media provides us with confirmation bias on steroids.
“In the past we may have read a newspaper that had more balanced and alternate points of view.”
She said like it or not we do compare ourselves to others and relativities matter to most people, even more than absolute outcomes.
“How we are doing compared to others affects how we feel and our decision making,” she said.
“Keeping up with the Joneses, which is all about maintaining our status relative to others, is now keeping up with the Kardashians.”
She said if you are on social media and you are hearing continual stories of how much easy money there is to be made, then it’s tempting to get on board.
“If your friends are becoming crypto millionaires and you are just limping along in your old school stocks, that hurts,” she said.
“Because your relative position is not great it puts pressure on you to make a sub-optimal decision – essentially you are feeling the pain of a virtual loss because you didn’t invest.”
She said hindsight bias could also be at play with would-be investors “knowing all along” that crypto was going to be successful, along with overconfidence bias where retail investors might believe they have incredible insights into markets, and they have unique insights and ability to invest wisely.
“Maybe they do but if they don’t, they may end up making risky decisions they regret in the future,” she said
“Warren Buffett’s right hand man Charlie Munger is all about managing behavioural biases and has a saying ‘invert, always invert’.
“He has had success in forensically considering the risks of each potential investment focusing in on what could go wrong rather than what could go right which keeps overconfidence at bay.”
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