David Lewis, Kelly Peters, and Dan Ariely wrote an article for The Globe and Mail titled How investors can stay rational in irrational times.

« Despite our best efforts to be rational decision-makers, we often are predictably irrational. In the 1950s, Herbert Simon described people as boundedly rational – we try to be rational but only have so much mental energy and time, so we often fail. Kahneman and Tversky’s work in the 1970s showed that our reliance on heuristics in the face of these time and energy constraints, can lead to predictable biases. »

« we see the bias of loss aversion taking root. People feel the pain of losses more acutely than pleasure from an equivalent gain, leading them to myopic viewpoints  »

My comment: That doesn’t sound so irrational when you consider, it takes a 67% gain to recover from a 40% loss.

« To counter loss aversion, we can encourage investors to use mental accounting (Thaler, 1990). If people separate their money into a portion they need for short term emergencies and the rest of their money as being long term, and leave that long term money in the market knowing that it will eventually recover and earn back any losses, they can be less tempted to dump everything at an inopportune time. Another technique is long-term gain framing. Look at the markets over a 10 year period and the large drops we see daily look like small blips. One good piece of advice is to actively limit how frequently you look at your account. »

« To fight representativeness bias we can use explicit emotion priming (Blanchette 2007) where we acknowledge negative emotions and confront them. When emotions such as fear and anxiety are confronted and recognized as natural responses to stressful times, they lose their ability to hijack our thinking… People who took a long term view in 2008 and stayed in the market are much better off than those who panicked and stuffed their money in their mattress. Thinking of the long term can remove the temptation to react to short-term information. »

« Countering the illusion of control can be done by explicitly recognizing and framing the losses of forgone gains when the market eventually turns, and we know people are averse to losses. If they move at the bottom, they will lose out on the eventual rise. Another way of countering the illusion of control is by priming self consistency. Remind people that they thought carefully when constructing their portfolio, and the portfolio may have done very well for years, and this leads them to pause before unwinding it all. »

« Ask investors… to name people who consistently and successfully time the market by selling just before the crash and buying back in right at the bottom. They will have trouble naming any and in the long run, there are none. »

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