Emotions and cognitive biases can impair decision-making, especially during periods of volatility. Marcel Hoffmann, Head of Portfolio Management at Deutsche Bank Private Bank, explains how the right investment framework can help mitigate impulsive reactions to market movements.
What is behavioural finance?
Behavioural finance is the study of how psychology can influence financial decision-making. It looks at the gap between how investors might be expected to behave in theory and how they often behave in practice, particularly when emotions, past experiences or cognitive shortcuts affect the way they interpret risk, reward and market information.
It could also help explain why disciplined investing can be difficult. In periods of market stress, investors are analysing information while also managing uncertainty, discomfort and the natural desire to be proven right.
When investors lose their nerve and exit the market, behavioural factors often take over. Many of those who step aside might struggle to reinvest at a lower level.
Marcel Hoffmann
Head of Portfolio Management, Deutsche Bank Private Bank
“This is why we take the time to learn how clients respond emotionally, as well as rationally, to market moves,” says Marcel Hoffmann, Head of Portfolio Management at Deutsche Bank Private Bank. “A discretionary portfolio management service can help overcome these biases by outsourcing responsibility for certain investing decisions. But only if there is complete clarity and trust about what the portfolio manager will do under different conditions."
Three common behavioural biases in investing: loss aversion, confirmation bias and ownership bias
Three biases are particularly relevant for investors, Hoffmann notes:
- Loss aversion can make declines feel more painful than equivalent gains feel rewarding. This may encourage investors to reduce risk after asset prices have already fallen, even if their long-term objectives and risk profile have not changed. The result can be a permanent interruption to a strategy that was originally designed to withstand volatility.
- Confirmation bias can then reinforce the decision. Once an investor has sold, they may give more weight to information suggesting markets will fall further and less weight to evidence that conditions may stabilise. “You want to be right with your decision,” explains Hoffmann. “Your expectation is that markets need to fall further. If they do not, the markets are not correct – it is never you.”
- Ownership bias can also affect judgement. Hoffmann gives the example of an investor who researches a stock carefully, weighs the pros and cons and decides to buy. “Once you have done that, your relationship to the stock may change a great deal,” he says. “You will not be neutral anymore.” Positive news may be overemphasised, while negative information is dismissed because it conflicts with the original thesis.
These biases do not only affect private investors. Professionals are not immune either. The difference is that a structured investment process is designed to create checks and balances: separating analysis from impulse, challenging assumptions and keeping decisions anchored to a broader framework.
How a structured framework can improve investment decision-making
A defined investment framework could help investors avoid letting short-term volatility dictate long-term strategy. Rather than treating every market movement as a reason to rethink the portfolio, it offers a way to review whether the investment rationale has materially changed, whether the portfolio remains aligned with agreed objectives, and whether any action is supported by evidence rather than emotion.
Such a framework may also help investors consider the role that different asset classes – including, where suitable, the generally illiquid alternatives and private markets universe – may play within their overall asset allocation, taking into account their objectives, risk tolerance, time horizon and liquidity needs.
Discipline forms part of a professionally managed decision-making process. Portfolio managers can draw on market insights, CIO views, research, risk analysis and portfolio construction expertise, while reviewing ideas and exposures on an ongoing basis. This cannot remove uncertainty or guarantee the outcome of every decision, but it may add a layer of professional judgement when investors might otherwise react to fear, regret or overconfidence.
For Hoffmann, that separation is one of the main benefits of a managed approach. “We have a team of investment experts,” he says. “Your views and your investment decisions are challenged every time. We are used to doing that, and we have risk limits – but activity does not necessarily equal frequent trading.”
How professional portfolio management can help reduce emotional investment decisions
One potential benefit of delegating day-to-day portfolio decisions is the additional distance it can create between market events and investor reactions. When markets fall sharply, the temptation to step aside can be strong. Yet Hoffmann argues that this is often when behavioural mistakes are most damaging. “When investors lose their nerve and exit the market, behavioural factors often take over,” Hoffmann says. “Many of those who step aside might struggle to reinvest at a lower level.”
“When it comes to setting up a discretionary mandate, we work closely with clients to assess their circumstances, goals, investing experience, risk appetite and potential behavioural biases,” Hoffman explains. “Only then do we seek to identify a mandate that aligns with their investing style, as well as being suitable for their needs.”
How strategic asset allocation could help investors stay invested
Strategic asset allocation is the long-term framework that determines how a portfolio is divided across asset classes, such as equities, bonds, cash and other investments. It helps align investment decisions with an investor’s objectives, risk tolerance and time horizon. Because every investor has different goals and behavioural responses to risk, there is no “one size fits all” approach. This is why investment strategies are often structured around different profiles, such as income, balanced or growth, each with its own risk and return characteristics.
We work closely with clients to assess their circumstances, goals, investing experience, risk appetite and potential behavioural biases.
Marcel Hoffmann
Head of Portfolio Management, Deutsche Bank Private Bank
This long-term framework can also support behavioural discipline. Rather than constantly adjusting to short-term market noise, investors can use strategic asset allocation to assess whether the portfolio remains consistent with their objectives, liquidity needs, and ability to withstand volatility.
“We believe staying invested is the appropriate approach,” Hoffmann says. In his view, this starts with “a proper and thorough strategic asset allocation”, set up carefully enough to help investors stay the course through difficult periods while keeping their objectives in mind.
How tactical asset allocation can support long-term portfolio discipline
Tactical asset allocation can complement a long-term strategic framework by allowing selective adjustments as market conditions change. Rather than making broad portfolio changes in response to short-term volatility, investors may adjust exposures in a disciplined way, reflecting changes in risk, valuation, market momentum or the macroeconomic environment. Used carefully, this can help keep a portfolio responsive while remaining anchored to its strategic objectives.
Why portfolio construction matters for diversification and risk control
Professional portfolio construction may add further value by looking beyond individual holdings to the way different exposures interact. A portfolio, Hoffmann explains, “is more than just a number of trades set upon one layer of each other”. A well-built portfolio is “a composition”, taking account of factors such as currency exposure, interest-rate sensitivity, sector concentration and other interdependencies that may only become visible under stress.
That broader view is especially important because apparent diversification can sometimes conceal hidden risks. As Hoffmann notes, “a lot of clients build their portfolios just doing trade, trade, trade”. Individual positions may each appear attractive on their own, but together they can leave the portfolio exposed to the same underlying factor. A managed framework can therefore help identify where risks are overlapping, where exposures may be too concentrated and where the portfolio may need a more balanced mix.
Building discipline for volatile markets
The potential cost of not staying invested may be significant. As an example, indicative analysis by Deutsche Bank showed that a 10,000 US Dollar investment in the S&P 500 would have grown to 116,746 if fully invested between 2 January 1996 and 31 December 2024, but to 53,486 – 54% less – if the investor had missed out on the 10 best days during that period, although past performance is not indicative of future returns; investments can fall as well as rise and investors may not get back the amount originally invested.
Nevertheless, in our view, this helps reinforce why staying in the market, even throughout volatility, could make a difference to long-term performance – as well as underlining the difficulty of trying to time exits and re-entries successfully.
None of the above removes market risk or ensures that every decision will be right, but it can potentially help create a more disciplined environment for making investment choices. As Hoffmann puts it, “the market will always test your ability to withstand losses”. The aim is not to avoid volatility altogether, but to build a portfolio and decision-making process that may make it easier to remain invested when that test comes.
Behavioural finance FAQs: investment biases, market volatility and portfolio discipline
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What is behavioural finance in investing?
Behavioural finance examines how psychology, emotions and cognitive biases can influence investment decisions. It helps explain why investors may act differently in practice than they might in theory, particularly during periods of volatility, uncertainty or market stress.
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How can behavioural biases affect investment decisions?
Behavioural biases can affect how investors interpret information, assess risk and respond to losses. Loss aversion may make market declines feel especially uncomfortable, confirmation bias can lead investors to seek evidence that supports an existing view, and ownership bias may make it harder to reassess an investment objectively.
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Why is loss aversion important for investors?
Loss aversion matters because investors often feel the pain of losses more strongly than the satisfaction of equivalent gains. This can encourage short-term reactions, such as selling after markets have already fallen, even when a long-term investment plan was designed to withstand periods of volatility.
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How does confirmation bias affect investing?
Confirmation bias is the tendency to give more weight to information that supports an existing belief and less weight to information that challenges it. In investing, this can make it more difficult to change course when new evidence suggests that an investment view or portfolio decision should be reviewed.
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Why can staying invested matter during market volatility?
Staying invested can matter because some of the strongest market recovery days may occur close to periods of sharp decline. Investors who move to the sidelines during stress may risk missing part of the rebound, which is why a disciplined, long-term approach can be important when markets are unsettled.
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How can a structured investment process help reduce emotional decision-making?
A structured investment process can help by introducing defined objectives, risk parameters, research inputs and regular portfolio reviews. This creates a framework for testing assumptions and assessing whether action is supported by evidence, rather than by fear, regret or overconfidence.
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What are the benefits of professional portfolio management?
Professional portfolio management may provide access to dedicated investment expertise, risk analysis, portfolio construction tools and a more systematic decision-making framework. It may also help identify hidden concentrations, overlapping exposures and behavioural risks that individual investors can find difficult to assess on their own.
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How should investors think about risk, return and liquidity?
Investors should consider how much volatility they can realistically tolerate, what level of loss would affect their ability to stay invested, how much access to capital they may need over different time horizons and whether their return expectations are consistent with that risk profile. A realistic risk-return framework may make it easier to build a portfolio that remains aligned with long-term objectives.
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