ELLEVEST INSIGHTS

“The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.” — Warren Buffett

September marks the official end of summer with kids returning to school, parents getting back into their daily routines, and, depending on where you live, fall colors begin to pop. This September also marked a shift in monetary policy. During their most recent meeting on September 16, the Federal Reserve raised the federal funds rate by 25 basis points in an effort to fight inflation. This is the first rate hike in three years and all 12 members of the committee voted unanimously to approve it. 

The market’s initial reaction to the rate hike and the press conference that followed was cautious but by the end of the week it felt like both the equity and bond markets let out a sigh of relief. Market performance in September was choppy as investors faced a barrage of conflicting headlines, including the back and forth between the US and Iran, energy costs spiking again, rising Treasury yields that prompted Scott Bessent to increase the bond buyback program, Canadian tariff disputes, and broader anxieties over AI disruption (just to name a few).  

Despite this wall of worry, diversified portfolios are having a very strong year. As of September 30, the S&P 500 is up 13%, International Developed equities follow closely at 10%, and Emerging Markets continue their momentum surging 23%. Bonds have been everywhere on the news recently as they struggle with rising Treasury yields. While the headlines paint a dire picture, investment-grade bonds remain down roughly 2% year-to-date buffered by their attractive starting yields. 

When compared to the long-term historical S&P 500 average return of ~10% since its launch in 1957, three-year performance numbers look exceptionally strong. A globally diversified equity portfolio has returned approximately 23% annualized over this period. An investment in a broad US stock market index fund has doubled in just four years. So this raises the question, with a backdrop this solid, why does investor sentiment feel caught between anxiety and complacency?

The Behavioral Conundrum

One of the reasons I love my job is because investing is as much human psychology as it is financial analysis. A core assumption of classical economics is that market participants are rational and make decisions that maximize utility. Behavioral economics, pioneered by Amos Tversky, Daniel Kahneman, and Richard Thaler, demonstrated that human decision-making is not always rational and is largely influenced by emotions, experiences, and cognitive limitations.

Today’s investor sentiment and outlook for the future highlights this friction across every major asset class. In equities, investors hesitate to allocate fearing the market has had its run, is highly concentrated or is in an AI bubble. When it comes to bonds, investors remain wary due to persistent inflation, a US national debt crossing $40 trillion, and corporate hyperscalers flooding the debt markets. And with private alternative investments appetite has also cooled amid concentrated or postponed exits and “paltry” returns relative to public equity markets.

When every asset class feels like a trap, investors often default to analysis paralysis. These worries have real data behind it but to navigate this market environment effectively, investors must recognize the psychological biases that can influence their judgment. 

Biases in a Bull Market

In one of my favorite books, Thinking in Bets, the author Annie Duke talks about resulting bias which is the tendency to judge the quality of a decision based on its outcome. In volatile markets, a sound, risk-managed strategy can yield a disappointing short-term result due to bad luck, while a risky and highly concentrated bet can pay off handsomely due to good timing. Evaluating portfolio decisions solely on recent performance leads investors to abandon disciplined strategies at precisely the wrong time.

Confirmation bias drives us to search for, favor, and remember information that reinforces our existing views and beliefs while discounting contradictory evidence. Ellevest’s CIO, Ankur Patel, wrote about this in last month’s market insights. We see this in equity markets all the time … where two entirely opposing narratives can be true and both can have valid data points. Investors often choose the one that already fits their narrative.

During prolonged bull runs, investors frequently overestimate their skills. When a single speculative stock worked out in your favor, low double-digit projected returns in private markets or 5% bond yields suddenly feel unexceptional. Overconfidence bias can often lead investors to overestimate their risk tolerance right when prudence and diversification is needed most. Additionally, overconfident investors tend to trade more frequently which can drive up taxes and transaction costs.

Recency bias leads individuals to overweight recent events while underweighting long-term historical trends. When markets are up, it can feed overconfidence and create a false sense of security that encourages late-cycle risk-taking. On the other hand, focusing exclusively on recent negative news causes investors to hoard cash, quietly destroying their purchasing power and causing them to miss out on long-term market growth.

Moral of the story? Try to be accurate, not right.

Behavioral biases are powerful and have real implications. The goal is not to eliminate them because as human beings, that is impossible. Cognitive biases can be moderated by recognizing flaws in logic and correcting our thinking. Emotional biases must be adapted by creating rules and frameworks that neutralize our impulses.

As Duke notes in her book, when it comes to decision-making try to be accurate and not right. Being right is a yes or no scorecard while being accurate means making the best decision with the information that you have. In poker, if you go all in with pocket aces and lose on the last card, you weren’t right, but you were accurate. Investing works the same way. It’s impossible to predict market performance so the accurate move is to invest in a well-diversified portfolio with the right mix of growth and income for your goals. When it comes to investing, there is no substitute for discipline.

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If you are looking for another book recommendation or want to learn more about behavioral economics, I highly encourage you to read Misbehaving: The Making of Behavioral Economics by Richard Thaler. In my opinion, it has many applications in life beyond investing.