Bulls, Bears & Biases

Over the past couple of years, the retail investment landscape has grown in multitude. Compared to 10 percent in 2019, retail investment activity makes up almost 25 percent of all trading in the US today ^[1]https://markets.businessinsider.com/news/stocks/retail-investors-quarter-of-stock-market-coronavirus-volatility-trading-citadel-2020-7-1029382035  The surge in retail investing was initially fueled by the introduction and growth of innovative product offerings from easy-to-use, beginner-friendly trading platforms like Robinhood and Acorns, to behaviorally-driven robo advisors like Wealthfront and Betterment. While these have been around for a decade now, usage has exponentially grown since 2019. Moreover, with the onset of COVID-19 and the economic disruption that followed, many turned to retail investing as “a new source of empowerment,” and a “stabilizing force” in times of uncertainty.^[2]https://www2.deloitte.com/content/dam/Deloitte/us/Documents/financial-services/us-the-rise-of-newly-empowered-retail-investors-2021.pdf In light of these and many other social forces, the retail investing ecosystem has seen a change in trading behaviors and norms. How and why people choose to put money into – or pull out of – the market is in constant flux. As such, acknowledging the underlying biases driving these decisions has meaningful implications for the investment management industry at large.

How and why people choose to put money into – or pull out of – the market is in constant flux. As such, acknowledging the underlying biases driving these decisions has meaningful implications for the investment management industry at large.

Following the pandemic and the market instability that ensued, many retail traders fell into the trap of ‘returns chasing behavior’, where one switches from low to average-performing investments, to better-performing alternatives.

^[3]https://www.schwabassetmanagement.com/content/loss-aversion-bias The theory of loss aversion is particularly common in the case of highfrequency and short-term trading, where investors are driven by the tendency to avoid losses over achieving equivalent gains. As witnessed with the Gamestop short squeeze in early 2021, even a price gain did not satisfy traders and led to greater risk-taking.^[4]https://www.nasdaq.com/articles/the-simple-reason-you-should-ignore-the-gamestop-mania-2021-01-29

The theory of loss aversion is particularly common in the case of high frequency and short-term trading, where investors are driven by the tendency to avoid losses over achieving equivalent gains

Additionally, herd behavior (when people adapt their behavior to model others) has grown among retail traders. With the rise of alternative information sources such as Reddit and Twitter and more first-time investors entering the market, the likelihood of persuasion increases as an individual is exposed to more conversations surrounding a given investment.^[5]https://www.ft.com/content/971df303-726a-4bdf-93eb-9a9e848f7109

Combined together, loss aversion and herd behavior result in a persistent ‘push-and-pull’, where investors push funds into investments after a period of strong market performance and pull following low to average performance. While this strategy may fare well for those more experienced, younger and more novice investors are more likely to be driven by loss aversion and herding behavior.^[6]https://www.ncbi.nlm.nih.gov/pmc/articles/PMC8027695/

Combined together, loss aversion and herd behavior result in a persistent ‘push-and-pull’, where investors push funds into investments after a period of strong market performance and pull following low to average performance.

Moreover, the rise in fintech and digital trading apps such as Robinhood, Acorns, Stash have encouraged first-timers and younger investors to enter the market. In addition to these newer players, more established platforms like Fidelity, Charles Schwab, and TD Ameritrade have lowered barriers to entry, by offering user-friendly interfaces, low to no commission trading, and free financial literacy tools for investors. Retail investors are turning to non-traditional sources for financial advice like Twitter, Reddit, and LinkedIn. Research by Willis Owen via JPMorgan found that a third of retail investors have made at least one change to their investments as a result of an announcement on social media.^[7]https://www.chase.com/personal/investments/learning-and-insights/article/social-medias-influence-on-the-investing-community

Collectively, both digital innovations and increased access to alternate information have propelled a rise in Do-It-Yourself or ‘DIY investing’, where an investor takes a self-directed approach to managing their investments. In doing so, they create and manage their own portfolio in lieu of a managed approach, where a financial advisor or institution assumes such responsibilities. Findings from a 2019 survey conducted by CNBC and Acorns found that only 75 percent of Americans manage their own investments, and 17 percent use a financial advisor to do so.^[8]https://www.cnbc.com/2019/04/01/americans-are-more-confident-about-their-retirement-savings-now-versus-three-years-ago-pre-trump-according-to-the-invest-in-you-savings-survey.html

While DIY investing has lowered former barriers to entry for many, investors still face the challenge of delineating between trusted, reliable sources of advice and less informed, speculative sources. When people believe they have a sense of control over their decisions – especially financial – they tend to overestimate their ability to curb losses and any feelings of uncertainty.^[9]https://www.businessinsider.com/false-sense-of-confidence-big-threat-young-investors-2020-9 This is evidenced following the events of 2021 – with the ongoing pandemic, the “Great Resignation” and a dampening of consumer spending, DIY investors are now less confident of their own abilities to manage their investments. According to a 2021 study by Northwestern Mutual, 20 percent of Americans stated that they were their most trusted source of financial advice – lower than the previous year’s 30 percent.^[10]https://www.cnbc.com/2021/08/28/americans-are-changing-who-they-turn-to-for-financial-advice.html

When people believe they have a sense of control over their decisions – especially financial – they tend to overestimate their ability to curb losses and any feelings of uncertainty.

While we cannot avoid some of these biases, both investors and providers can benefit from acknowledging these attitudes and behaviors. For instance, investors can take small steps like tracking prior investment choices and work with an advisor to periodically review their financial goals as they evolve. These actions also enable investment providers to stay abreast and proactively mitigate these biases at scale. In doing so, both investors and players across the investment management space benefit from more informed decision-making, a stronger ability to maneuver periods of uncertainty, and achieve better financial outcomes.

About the Author
Anu Raghuram is a data scientist at BlackRock, engaging in data-driven research initiatives across the firm. She is passionate about using data to understand human behavior, inform decisions and drive growth. Find her on LinkedIn here.