Question

Consider two scenarios described below. For each scenario discuss at least two psychological or behavioral factors which make it hard for investors who sell their stocks into a steep decline to get back into market in future.

Scenario 1: The stock prices go after they sell their stocks (Remember that you must discuss two distinct psychological/behavioral factors.)

Scenario 2: The stock prices go down after they sell their stocks (Remember that you must discuss two distinct psychological/behavioral factors.)

Question 2: Explain why investors’ expectations of future performance of portfolios (such as mutual funds) tend to be negatively correlated with portfolios’ actual returns.)

Answer 1

Scenario 1: In case of stock prices gone up after the investor sell their stocks makes hard for him/her to invest again in future. It is because, the basic psychology behind investing is earning profits. In this case, the investor feels that he may have earned more if he has kept some patience. He thinks that his money invested has gone down. Secondly, this is situation of sunk cost trap when the investor feels that he has made wrong choice and decision.   

Scenario 2: When stock prices go down after selling the stocks creates a positive image in the mind of investor. He feels that he has made right decision and feel right for it and believe that if he would not made the decision of selling the stock, he may have incurred loss. However, here the second psychological situation may arise which may be called as superior trap. Here, investor feels himself superior and even better than the market experts and start try to make advices on the share market. This situation promotes him to invest more in future.

Ans. 2. The investors expectations of future performance of portfolios are negatively correlated with actual returns of the portfolio because the he can never predict the future. It is very uncertain. Actual returns depends a lot on many factors in the market and economy.