“Worst start since WW2”: But expert says buy the dip

Posted: 10 May 2022 4:29 pm
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Share markets around the world are off to their worst start since 1942, but investors need to analyse fundamentals over the latest market headline, a behavioural economist warns.

It has been a rough start for world markets.

So far 2022 has seen the tech-heavy NASDAQ 100 fall into a bear market, down 26%.

At the same time, the S&P 500 is down 16.79%, while in Australia the ASX 200 has fallen 7% year to date.

And while uncertainty remains high led by rising inflation, conflict in Ukraine and international lockdowns, RMIT's associate professor of finance, Angel Zhong, urges investors to take emotions out as markets fall.

"Retail investors tend to overreact to new information, inducing an impact on stock prices that is larger than appropriate," she said.

But the professor points out these price changes produce an overreaction, which over the long term dissipates, especially when they see negative impacts on the news.

"This is also related to a behavioural bias called 'availability bias', whereby people tend to heavily weight their decisions toward more recent information, biassing judgement towards recent news," Zhong said.

"Experimental evidence also finds that retail investors overreact differently to good vs bad news. The overreaction to bad news is more severe and investors tend to draw overly pessimistic conclusions about the future."

Picture not describedSource: Bloomberg

Retail investors "sell low and buy high"

Unfortunately, this bias to newer information is likely to see investors sell when the market is low and buy when the market is high.

In fact, loss aversion theory suggests we experience losses asymmetrically more severely than gains which means we are more likely to behave irrationally and make bad decisions such as holding an underperforming stock.

The flipside is also true with Zhong saying retail investors overreact to market falls and sell too much too early during a market correction.

"In the short run, these will cause temporary downward pressure on stock prices," Zhong said.

"As these are temporary movements, markets will self-correct and prices will go up again to tease out the noises. And by then, prices may rise to a higher level than they originally commit to," she said.

3 tips to help you overcome this bias

While emotionally investing is costing investors gains, Zhong notes once investors understand these biases they can overcome them.

"You need to actively monitor your portfolio, instead of actively trading. Avoid buying stocks that have risen too much and panic selling in bad times. React to news and market movements in the perspective of your long-term goals," she said.

To help overcome this bias, Zhong gives investors 3 handy hints:

  1. Always bear in mind that emotions can cost money and that it is important to take emotions out of investing.
  2. Do not get overly emotional by a headline you read but instead take the time to understand the information presented.
  3. Have a long-term strategy and stick with it.

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