Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Successful investing is about more than picking the right funds or stocks. Investor emotions and behaviour can significantly impact returns and outcomes.
With a general understanding of investment psychology, financial advisers are better positioned to support clients through market ups and downs, helping them avoid common traps so they are in a better position to meet long-term goals.
Why financial advisors should know about investor psychology
How an investor reacts to market conditions often dictates the long-term performance of their portfolio. Emotional decisions – fear, greed or envy – can result in costly mistakes, derailing carefully constructed investment plans.
For advisers, recognising and addressing these psychological pitfalls is key to supporting clients.
Common behavioural biases
Some of the most common behavioural biases exhibited by investors are outlined below:
Fear of missing out (FOMO) – This trait leads investors to focus on what could have been, rather than their actual returns. This ‘regret’ is powerful, with studies suggesting Olympic bronze medallists tend to be happier than silver medal winners, because the latter focus on how close they were to the top spot.1
In investment, FOMO often means investors fixate on the money they could have made from the best-performing stock, fund, or index.
This can occur with diversified portfolios, which are designed to manage risk. These may lag behind market indices at certain times, particularly when market gains are driven by a few stocks. But FOMO can also mean investors overlook how such portfolios are less likely to experience steep losses during downturns.
Chasing the highest returns or attempting to time the market often results in poor outcomes. Advisers can help clients avoid FOMO by highlighting the importance of diversification and showing how it potentially delivers more stable returns across different market cycles. While diversification may not outperform specific indices in the short term, it reduces the likelihood of severe losses and smooths returns over time.
The Lottery Effect – This is often linked to FOMO, with investors often drawn to ‘hot stocks’ or trendy start-ups, hoping for big gains. Like buying a lottery ticket, the potential ‘win’ can distort their perception of the odds. In reality, chasing the next big win carries a much higher chance of loss.
Advisers can promote a more balanced approach to risk and return by focusing on steady, reliable gains. For instance, over the past five years, a random stock from the S&P 500 had a 37% chance of losing money. By contrast, only 1% of ETFs or diversified funds lost money in the same period.2
Risk: Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.
Loss Aversion – Investors tend to feel the pain of a loss far more acutely than the pleasure of a gain. Research shows that losing £100 feels twice as painful as gaining the same amount feels positive.3
This fear of loss can lead to rash decisions, such as selling off assets during downturns to avoid further losses. In reality, this often crystallises losses and can have a longer-term impact on returns.
Advisers can support clients by reassuring clients during market turbulence, explaining that volatility is a normal part of investing, and that since no one can predict when the ‘best days’ in the market will occur, time in the market – rather than timing the market – is what leads to better returns.
Action bias – This describes the tendency for investors to feel the need to ‘do something’ to protect their money, particularly during volatile periods. Even if they don’t sell equities, many may try to rebalance their portfolios impulsively, which can lead to poor timing and missed opportunities.
Advisers have a critical role to play reminding clients that market downturns are inevitable and often short-lived. They can encourage investors to stick to long-term plans rather than reacting to short-term fears.
One useful analogy is that of a goalkeeper in a penalty shoot-out: statistics suggest the best strategy for stopping a shot is to stay still, rather than dive prematurely.4
The importance of taking a disciplined approach to investing
Financial advisers don’t just manage clients’ portfolios or demystify the jargon; they also guide clients through psychological challenges by promoting disciplined investing.
This involves creating a strategy, keeping up regular communication, especially during market volatility, and focusing on education. Helping clients understand how investments work, the benefits of diversification, and the risks of emotional decision-making can empower them to stay the course.
As Warren Buffett, one of the most successful investors of the past few decades, has said: “We don’t have to be smarter than the rest. We have to be more disciplined than the rest.”5
How BlackRock can help
Client requirements of financial advisors have never been as complex as today. BlackRock offers a wealth of information and resources to help advisers assist their clients in understanding the fundamentals of investing. Financial advisers can contact BlackRock’s UK Adviser team for further details.
BlackRock is also proud to support the VouchedFor campaign in 2025, aimed at building consumer trust and enhancing understanding of the advice profession.
Find out more at BlackRock MyMap
Sources
1 Medvec, V. H., Madey, S. F., & Gilovich, T. (1995). When less is more: Counterfactual thinking and satisfaction among Olympic medalists. Journal of Personality and Social Psychology, 69(4), 603–610. https://doi.org/10.1037/0022-3514.69.4.603
2 Source: Morningstar as of 12/31/22. Diversified investments are represented by the Morningstar U.S. Equity Category, oldest share class only. Individual U.S. stocks are represented by the Morningstar U.S. Stock Universe, all securities on the NYSE and NASDAQ. Analysis does not include obsolete mutual funds, ETFs or stocks as defined by Morningstar.
3 Medvec, V. H., Madey, S. F., & Gilovich, T. (1995). When less is more: Counterfactual thinking and satisfaction among Olympic medalists. Journal of Personality and Social Psychology, 69(4), 603–610. https://doi.org/10.1037/0022-3514.69.4.603
4 Why More Goalkeepers Should Stand Still at Penalties (theanalyst.com)
5 Mastering the Art of Discipline: Insights from Warren Buffett, January 2024
