Our state of mind influences the decisions we make. And investment decisions are no exception to this. Our decisions have huge implication on investment portfolio. In fact, there is a possibility that our behaviour may fetch not so good returns.
In this context, the latest episode of ‘Smart Investing’ hosted Prasad Ramani, Founder, Syntoniq and Shailendra Dixit, Zonal Head, Investor Education & Distribution Development, Aditya Birla Sun Life Mutual Fund, who helped the audience to make informed financial decisions. The episode was moderated by Nishant Patnaik, Associate Editor, Cafemutual.
Here are the three key takeaways from the session:
- Behavioural biases and their impact
Today investors are exposed to a lot of information. With new information, they get tempted to act in a particular way that may not necessarily be fundamentally right. Such decisions may result in higher risk.
For example, loss-aversion is a behavioural bias where investors are afraid of losses. In the fear of making losses, investors usually land up taking more risks. To elaborate, when a stock priced Rs. 100 falls to Rs. 80, investors tend to hold on to it until its price rebounds. However, it is advisable to analyse the reasons behind the drop as such analysis could hint at exiting as the next best thing to do.
Also, when a particular fund fails to perform well, investors typically focus on that particular fund rather than understanding the placement of that fund in the overall portfolio. This behavioural bias is known as ‘myopic loss aversion’. However, investors here should hold a portfolio view and not a fund-specific view.
Further, most of the time, biases override numbers and analysis. Under confirmation bias, investors selectively consider only those facts/numbers that match their beliefs and conveniently supersede other facts/numbers.
- Common money mistakes
The biggest mistake that investors make is extrapolating the current situation to the future. To elaborate, a working professional drawing a handsome salary would like to believe that the current comfort would continue to exist even in the coming years. This is when investors take a back foot when it comes to saving for the future. However, keeping a slightly negative mindset helps investors to prepare and plan for the worse, like job loss, medical emergencies, etc.
Another common mistake that investors make is giving importance to smaller things instead of focussing on big picture. This can be well understood from the example of an investor who constantly strives to buy products at the best available discounted rates but invests money in less-rewarding traditional instruments that cannot beat inflation.
Additionally, many anticipate the domestic industry to replicate the financial trends of the west. However, it is important to be mindful of the fact that mutual funds are relatively new in India and trends in other foreign markets may/may not repeat in the domestic market.
- Making unbiased financial decisions
The most important thing is to focus on a process. Beating inflation should be the primary focus rather than returns. Secondly, investors should be mindful of risk, which emerges from wrong choices made. Next, they should look into the associated risks, which can be taken care of through a suitable asset-allocation strategy. This is where the expertise of advisors/MFDs comes into play.
Bonus: Tip for advisors
What we communicate and how we communicate plays an important role in guiding investors to make unbiased decisions. Understanding investor psychology makes it easier to communicate information in a personalised manner.
For example,
“If you want to generate inflation-adjusted returns, you should exercise discipline in investing over the long term” - This is what promotion-focused investors should be conveyed. Promotion-focused investors are those who are more worried about what they gain.
On the other hand, prevention-focused investors are worried about what they can lose. Such investors should be communicated, “If you do not exercise discipline in investing over the long term, you may lose on generating inflation-adjusted returns.”
The message conveyed under both scenarios is the same but the way it is communicated matters.
Watch full video here
