As an advisor, you would have come across clients who talk about the windfall returns that their colleagues or friends have made from their investment; and now they want to invest in the same products. This is a classic example of outcome bias.
Many times investors look at just outcome and not the underlying reasons that have led to a particular outcome. Simply put, overemphasis on performance or returns usually creates an outcome bias.
We spoke to a few advisors to understand how they have helped their clients overcome outcome bias.
Azeem Jagani, Composite Investment Services
A few years back, a client approached me to seek my opinion on mid and small cap funds. He wanted me to switch his entire investments in these funds as the mid and small cap funds were then delivering 20% CAGR.
I remember that he was just obsessed with the outcome. I asked him the reason for his conviction and what kind of returns he was expecting from mid and small cap funds in future. He told me that since these funds have delivered extraordinary returns in the past, he would be able to meet his financial goals faster if he increased his exposure to these funds.
To make him understand about this outcome bias, I used past data to explain to him how mid and small cap funds react to market volatility. I also told him that if the market goes down, his financial goals would go for a toss as these funds typically fare very badly in market downturns. He finally relented.
Eventually, when things turned around in the markets, he thanked me for saving him.
Shifali Satsangee, Funds Vedaa
One of my HNI clients told me that he had received a tip that the market was going to surge after a particular event (union budget or election result). He asked me to invest a lump sum amount on his behalf to take a tactical call. He said he was quite convinced as his friend had made windfall gains by taking a similar call in the past. Clearly, he was attracted by the gains made by his friend.
I told him about outcome bias and showed him how the markets had actually reacted to these events in the past. He was surprised to see that markets had delivered negative returns most of the time on these occasions.
I showed him the right risk-reward perspective of an investment to align his expectations with his risk appetite. Later, he realized that he was just considering the best-case scenario and ignoring the possibility of downfall.
