Tackling behavioural biases in investment decisions
Please consider the below picture:
Can you tell which line is longer? Is it line A or line B? You have got not more than 5 seconds to answer.
If you are like the rest of us, line B appears to be longer than A.
But believe it or not, both the lines A and B are exactly the same length. You can check the following image if you are not convinced.
In day-to-day life, our intuition — let’s call it gut feel; helps us in most of our decisions. However, as the above illustration depicts, we end up at the wrong end.
Ironically, we don’t learn from this illusion the next time we are in the same situation. In the investing world, investors also face similar plight and are often misguided to end up with wrong decisions.
The actions which may feel right in the short term can have adverse impact on long-term investing outcomes.
So, what can we do? The solution lies in setting up rules and following them religiously. Legendary investor, Charlie Munger has done a phenomenal work in this regard by writing clearly his ‘Frameworks’ of investing. It’s no wonder that successful investors stick to their strengths by setting clear investing philosophy and as Munger famously said, ‘good investors rather than being brilliant, try to avoid stupidity.’
“To invest successfully, one doesn’t need a stratospheric IQ. What is needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”
— Warren Buffett
The learning we all can draw is to start working on building our investment frameworks based on our investing history and behavioural insights. One can start with journalling every investment decision. Please consider following common behavioural errors that investors are subject to commit quite often:
- Panic selling
- This is often experienced during equity markets falls, bear markets. For e.g., global financial crisis in 2008, Covid crash in 2020
2. Procrastination in investing
- The market is at all time high…. I will invest when the market corrects etc.
3. Profit booking
- Mutual fund investors often forget that their fund manager keep making changes to the portfolio (read booking profits too) and take unwarranted actions without paying heed to their asset allocation
4. Riding fancies
- FOMO (Fear of Missing Out) often leads to chasing fancies and investors often end up with fancy losses
5. Prediction
- Investors follow so called expert predictions and forget personal finance is more about personal than about finance
6. Past performance
- Despite the disclaimer, investors are guilty of making decisions based solely on past performance. This is akin to driving your car looking at rear view mirror. Accident is waiting to happen, isn’t it?
We can consider following points to avoid aforementioned errors:
- Lay out investing frameworks based on past experience
- Write down clear investing philosophy taking into consideration one’s risk profile and financial objectives
- Swear by ASSET ALLOCATION, that’s the key
Article by:
Aditya Karnik — Aditya is a management graduate and a CFP who has spent over 12 years in the financial services industry. He has been associated with Sapient as a Wealth Manager for the last 3 years. He is a Federer fan and has a keen interest in Sports and Music.
