Why do markets dip after the clocks change? Why do investors become more risk averse in the fall? And what does this mean for your portfolio? We like to think we’re rational investors. We’re not. On the latest episode, professor Lisa Kramer explores how hidden behavioural biases influence our portfolios — and even shift global markets.
Why do markets dip after the clocks change? Why do investors become more risk averse in the fall? And what does this mean for your portfolio? We like to think we’re rational investors. We’re not. On the latest episode, professor Lisa Kramer explores how hidden behavioural biases influence our portfolios — and even shift global markets.
Show notes
Show notes
[0:00] Humans tend to overestimate our abilities. We tend to think of ourselves as better than average.
[0:33] Meet Lisa Kramer, a professor of finance at the University of Toronto, and an expert in the psychology of financial decision-making.
[1:20] While thinking we’re better than average benefits us in certain situations — think dating and job hunting — it can be detrimental to our finances.
[2:13] This over-confidence is clearest when people try to outperform the stock market.
[2:56] But beyond internal biases, there are also external factors that influence our financial decisions.
[3:19] Lisa and her colleagues studied how the clock changes influenced the market as a whole and found that the day after the clocks changed, stock markets tumbled. But why?
[5:30] Seasonal changes — like the shift to winter — also make us more risk averse, en masse.
[7:16] Lisa’s research shows this isn’t just in the stock market; investors sought out safer products, like mutual funds and treasury bonds, in the winter.
[8:44] What does this mean for companies?
[9:28] Will AI save us (hint…not so much).
[10:29] And can the average investor do anything to mitigate these biases (hint…not so much).
[12:30] “The best we can do is educate people that these are common biases, and get people to think about decisions that they've made in their own lives and self-evaluate the extent to which maybe they've been subject to these biases.”
Megan Haynes: As a species, humans are actually pretty confident in their abilities.
Lisa Kramer: So I show this a lot in my classrooms. When I ask a big group of people, how good of a driver do you think you are relative to everybody else in this room, about 70% of the people in the room will put up their hands saying they're above average. We see more than half of the people thinking they're better than the average, which is just mathematically impossible.
It's just really deeply embedded in us that we think of ourselves as being better than the average.
I'm Lisa Kramer. I'm the Verecan Chair in Behavioral Finance at the University of Toronto and Rotman School of Management.
MH: Lisa studies behavioural finance — the psychology behind our financial decision making. And she’s found that, while most of us think we’re pretty rational and logical when it comes to money, we’re actually quite influenced by all kinds of human quirks. But what happens when we see those quirks show up en masse — influencing millions of people at once?
Her research has shown that there are synchronized patterns to our financial decision making that move entire markets. So what does this mean for our portfolios or the broader economy?
And is there a way to compensate for our biased decision making? Welcome to the Executive Summary. I’m Megan Haynes, editor of the Rotman Insights Hub.
Musical interlude
MH: Let’s kick this episode off with what we hope won’t be a preposterous idea.
LK: People are human — news flash — and as humans, we are subject to our emotions, all sorts of behavioral biases. Most of us think that we're a lot more rational than we probably are. Most of us think that we're smarter, better looking, basically above average in all sorts of metrics.
MH: And this can be great if you’re on the dating market and need to project confidence or going in for a job interview and are trying to sell yourself.
But in a financial context, it’s not ideal — because on average, we tend to overestimate our financial prowess.
And when we don’t recognize that bias in ourselves, it quietly shapes how we make financial decisions.
In one of the simplest of examples, that often means we try to outperform the market — people who are overconfident in their investing abilities, for example, will make more stock trades or move their money more frequently, trying to time the market to get the best returns. But in reality…
LK: Just by trying to do that, we act in ways that end up making it harder for us to even do as well as the average market performance. So that's just one example that ends up happening through people trading too much or trading at the wrong times, when it would actually be better to just kind of sit tight, have your portfolio, leave it there for the long haul — you'd end up doing as well as the market — but by trying to outperform, you can often end up underperforming. So it's pretty consequential that we're human, but under-appreciate the degree of our human nature.
MH: And while our internal biases shape how we individually make decisions — often without us realizing it — there are also external forces that can influence all of us at the same time.
And when that happens, the effects don’t just show up in individual portfolios — they show up in the market as a whole. Take daylight savings time… it turns out that clock changes have really consequential impacts on how we treat our money.
LK: So psychologists have shown that whenever we experience a disruption to our typical sleep patterns, we experience what's called sleep desynchronosis, and it's a lot like jet lag. It has implications for our cognition, our decision making, probably our anxiety levels.
MH: There have been some pretty well-documented negative consequences of time changes over the years — researchers have found that, for example, car accidents go up after the clocks shift — but Lisa and her colleagues wanted to see how daylight savings might influence our investing behaviour. Looking at stock returns back to the 1960s across four countries, they found that the day after the clocks change — in both the fall and spring — there was a pretty significant impact on financial markets.
LK: In markets all around the world that we've looked at, the trading day following the time change, markets are less positive or more negative on average than they would be on that typical trading day following the time change.
MH: Basically, on the Monday following a time change, market returns are significantly worse, most likely because we, as a whole, become more risk averse.
LK: When the clock changes by an hour and our sleep is disrupted and we're feeling more anxious, we're probably less likely to be willing to hold a risky security like a stock.
MH: If we’re less willing to hold risky stock, we’re more likely to sell it or less likely to buy it in the first place, and if everyone is feeling the same way on the same day, you see a dip.
And this happens whether we’ve gained an hour of sleep in the fall or lost an hour in the spring. It’s the change to the schedule that causes the sleep disruption, which ultimately costs us and the economy… literally.
LK: When we looked at the U.S., it was about $30 billion in losses per time change, and that was sort of back in around 2000 we were looking at this. So if we were to redo it today, it could very well be much larger inflation adjusted.
Musical interlude
MH: Daylight saving isn’t the only external factor that can influence the money habits of an entire population.
LK: After we wrote that paper on Daylight Saving Time changes, we were interested in exploring whether there are other large effects that might synchronize populations across a country or a hemisphere or around the world. And we were talking to different psychologists, and UBC psychologist Stan Coren sort of put an idea in our head that it would be interesting to look at seasonal affective disorder.
MH: So seasonal affective disorder — or SAD — is a clinical depressive diagnosis that affects roughly 10% of the Canadian population. But when the seasons change and we get fewer hours of daylight, there is — generally — a dampening of moods for the average person, even if it’s not severe.
LK: When fall turns into winter and we're all feeling kind of crummy because of the reduced daylight, there is reason to think we might suffer effects that could spill over into our financial decision making.
MH: To study this, Lisa and her colleagues looked at nine countries across the globe.
They picked nations in both the northern and southern hemispheres, which spanned latitudes. They wanted to know whether financial markets lost their appetite for risk as they saw fewer hours of daylight.
And indeed, the researchers found that the further a country was from the equator — i.e., the more fluctuation it saw in terms of daylight through the year — the more likely the financial market in that country would see seasonal fluctuations.
LK: So starting in the fall, if people are becoming more risk averse, they're developing less of an appetite for taking risk, and this puts some downward pressure on prices and returns in financial markets.
MH: And it wasn’t just that Lisa and her colleagues saw fewer risky trades in the stock market. Further research found that treasury bonds in the US — considered a relatively safe investment portfolio — saw a spike in the fall months as people sought out safer places to park their money.
LK: We also took a look at mutual fund flows. So what are individual investors doing with the money that they allocate to mutual funds? And it seems in the fall they're shifting money away from risky mutual fund products and moving them towards safer mutual fund products and then reversing that in the spring.
MH: And this was a pervasive trend — even among professional or institutional investors, who have way more insights and, dare we say, knowledge at their fingertips than the average ma and pa retail investor.
LK: So the fact that those seasonal effects show up in a market that's so heavily dominated by those professionals is suggestive that they experience these human tendencies as well, which shouldn't surprise us. Just because you have a CFA or you work at a big financial institution, you don't suddenly become more robotic or non-emotional. It can be really hard to overcome these kinds of impulses.
Musical interlude
MH: Ok, so what can we do about it? It’s one thing to recognize that investors of all stripes are biased and that ends up shaping how they make financial decisions; it’s another to reckon with the idea that the entire market can be biased — say, becoming less risk averse when winter is coming — or that stock markets tend to be a bit depressed the day after the clocks change. So let’s start with businesses.
Well, businesses should be aware these biases exist and probably need to plan for some seasonal fluctuations in people’s risk appetite.
LK: There are ways that companies can think about when they're releasing information. If you release really inflammatory news in the fall, when people are feeling very risk averse, they're likely to have a more extreme reaction to that information than if the same news is released in the spring, when we're all feeling way more calm. Not everything in terms of announcements can be delayed by six months, though, so the extent to which we can exploit these things is a little bit constrained. But I do think it's important to think about these things.
MH: People should probably also be aware that AI won’t save us from our own biases and behavioural responses.
LK: I think we all kind of feel intuitively like AI must be immune from behavioral biases, or at least have the potential to be immune from behavioral biases. I'm still pretty skeptical on that point. Looking at questions of how markets are behaving more recently, say in the last five or 10 years, when algorithmic trading has become much more prominent in financial markets compared to earlier periods, I'm still seeing evidence of human nature in markets. And when I think about that, why might that be? You know, algorithms are products of humans. Humans program the AI algorithms, and in financial market situations, humans override the recommendations of AI algorithms. So those are a couple of ways that human nature can still sneak its way into markets.
MH: And what can the average investor do?
LH: I like joking that we should just all move closer to the equator so that we're not subject to these seasonal variations in our risk preferences, but that's not very feasible, I'm told by my husband.
MH: Sadly, we’re still a bit limited. It can be hard to even identify what type of biases you as an individual hold. Are you overconfident? Are you risk averse? Do you make rash decisions the Monday after Daylight Savings? Sadly…
LK: We don't have a ton of tools people can use to measure their own susceptibility to specific biases. So I think we have a long way to go to actually producing practical tools for investors.
MH: So for individuals trying to de-bias their decision making, the first step is to accept that — news flash — you’re human. You probably are more like the average investor than not, so recognize some external factors will probably shape some of your reactions.
LK: I think being aware that it's an aspect of human nature that your risk preferences might change seasonally. You can be aware of that before, let's say, markets start going crazy in the fall and you start feeling panicky. If you knew ahead of time that is a possibility, then you might be better prepared for it than if you weren't aware in the first place.
I think we're all unique in the propensity we have to exhibit these different behavioral biases. So it's hard to say for an individual which specific one might be worst, because it depends on the context of your own unique portfolio and the way you make decisions. But I think at some level, we're all susceptible to all of these, so the more we can learn about our human nature — reading books about behavioral finance for people who are trying to manage their own portfolios — I think it can be so eye opening so that we can all be alert to the different ways in which our behavioral biases can work their way into our decisions and potentially set us back relative to where we could be if we made our decisions differently.
The best we can do is educate people that these are common biases and get people to think about decisions that they've made in their own lives and self-evaluate the extent to which maybe they've been subject to these biases.
Outro music
MH: This has been Rotman Executive Summary, a podcast bringing you the latest insights and innovative thinking from Canada's leading business school.
Special thanks to Professor Lisa Kramer. Join us next month as we chat with Professor Sam Maglio about the science behind persuasive writing.
This episode was written and produced by Megan Haynes. It was recorded by Dan Mazzotta and edited by Avery Moore Kloss.
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