The big theme of investing for 2021 has been decision-making under uncertainty. When things are unpredictable or unreliable, cognitive and emotional biases can play an even bigger role in investors’ decisions. As Morgan Stanley wrote in an Aug. 2020 note, the pandemic has served as a trigger for emotional biases of many stripes.
While COVID wreaked havoc on the economy and personal and professional lives, it had a strange bedfellow: a housing market on fire and a stock market that performed extraordinarily well. Although the S&P 500 ended Dec. 30 up more than 29% for the year, it underwent jolting dips as skittish investors reacted to the delta and omicron variants and to President Joe Biden’s early tax proposal last April to nearly double the long-term capital gains rate. The combination of it all has been a jolt to the investing psyche.
Behavioral finance is the branch of economics and psychology that deals with the effects of cognitive errors and emotional biases on investors, both retail and institutional, and financial markets. Here are six behavioral finance lessons of 2021 for financial advisors and their clients: