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Despite being the most important thing in life, why do people make money mistakes?
Money is not just a math. While we can prepare our household budgets on an excel and try to be as diligent as possible in our saving and investing habits, we all are susceptible to making not so sound financial decisions. This is because of the common biases faced by investors in their day-to- day lives. One of the most common biases investors face is Recency Bias. This means our decisions are influenced by most recent events. For instance, investors may hold back on investing if they have witnessed a recent correction, feeling that markets may correct further. There are many other biases which investors encounter which impact their decision-making ability at different points in time.
Let me cite an example from the book ‘The Laws of Wealth’ by Daniel Crosby. The author states, “We expect if we meet a person we find kind and considerate today, that they will be equally so one year from now. Likewise, we expect that if a business is well-run and profitable today this excellence will persist. This expectation of constancy can lead investors to make poor decisions in times of both extreme optimism and pessimism.”
Lastly, while money is a medium of exchange, it is not necessarily the most important thing in life, at least for everybody. After all, being affluent and unhappy or being poor and happy are both true. Health, happiness and quality of the time you save is more important to live a purposeful life. This is corroborated by many studies which show that people derive more happiness from their experiences rather than their possessions.
What are the common mistakes that people make when it comes to investments?
Many investors invested in IPOs hoping to make a quick buck. Some made money while some lost. So, one of the most common mistakes is investing based on the current trend by getting influenced by media, friends or colleagues.
We believe people should get adequately insured (health and life insurance) before they start investing. The common mistakes include not saving for an emergency, taking on too much debt, investing based on recent performance, investing without understanding the product, attempting to time the market, investing without a goal and so on.
Reference Morningstar Annual Study on investor returns v/s fund returns (titled Mind the Gap). The data for U.S. investors suggests that mutual fund and ETFs generated 10-year CAGR of 9.4% (as of Dec 31, 2020) whereas the average investor earned 7.7% CAGR over the same period – a gap of nearly 1.7%. Essentially, attempts to time the market led to this difference in fund return and investor return.
Many a time, managing money involves emotion and the need to guard against our own biases. An efficient advisor can help in reducing financial anxiety and focus on having a plan, especially when markets are going through a rough phase. In such situations, an investor may take decisions based on one’s emotions. However, an advisor can bring in a third person’s perspective, helping make logical decisions rather than emotional. Even though an investor may be aware of the various behavioral biases, countering them in real-life decision making is easier said than done. This is where an advisor plays a role by constantly re-orienting one’s thinking towards long-term and end goals. A trusted advisor can also add value by being a sounding board in life’s major financial decisions like for e.g. to rent or to buy a house.
While we have been educating investors about behavioural biases for years, they still behave irrationally when they deal with money and investments. In such a scenario, how can RIAs/MFDs help their clients overcome behavioural biases?
Awareness is the first step. Firstly, intermediaries should educate clients about the different biases they face. All investments should be linked with a goal and the progress should be tracked so that clients are not distracted by short term noise. As compared to past when investors paused their investments in a bear market, investors today are more matured and try to buy the dip whenever there is a correction. This is the result of the continuous effort by industry and intermediaries in educating clients.
When it comes to avoiding behavioural biases, intermediaries can use this simple trick. Many of us like to buy things that we may not necessarily need, but the decision is simply influenced by external factor like “keep-up-with-the-joneses.”
One simple trick which has been found effective is to delay your purchase decision. Whenever your client feels like splurging something on luxury, instead of buying it instantaneously, ask them to delay the purchase by a day or two. By doing this, they will realise that they didn’t need it.
Further, behavioural nudges have to be built into products to provide different solutions. Automating investments through SIPs, default choices or features that help control behaviour bias can be used. Top up SIPs, lock in features, auto rebalancing feature of balanced advantage funds can be utilised to help keep emotions and irrational decision making at bay.
Along with investors, fund managers, at times, also make behavioural mistakes. As an AMC, how are you dealing with this issue?
Fund managers too are human beings and at times can make behavioural mistakes but as a fund house we have incorporated many filters into our investment process to mitigate such mistakes. For example, we have caps on sectoral overweight or underweight positions that a fund manager can take irrespective of his bullish or bearish stance on a particular sector. Diligently following the filters laid down in the investment process, having an evidence-based approach and leveraging a larger teams’ input and views helps in focussing on controlling the controllable and eliminating behaviour biases as best possible.
Putting in place a process helps us in mitigating biases. For instance, we factor in three filters while shortlisting any stock: 1) Operating Cash Flow positive for 7 out of 10 years, 2) Demonstrated corporate governance 3) Debt to Equity ratio < 3.
We place as much emphasis on managing risk and volatility as on generating returns. We adhere to rigorous research and risk management processes and emphasise on the strength of our teams over any individual.
Nowadays, many people make investing decisions with the help of search engines or social media. They do not realize that they are relying on advice which may not be reliable. How can the industry including AMCs and distributors deal with this issue?
Investors should use authentic sources of information to do their research. Even if they get some information from social media, they should verify it before acting on it.
Fund houses and distributors/advisers are doing their bit by conducting investor awareness seminars across the country. AMFI has also launched https://www.mutualfundssahihai.com/en which can be used by investors to learn about mutual funds. Websites of AMCs such as Money and Me by PGIM India MF, also have a repository of information in the form of articles, videos, which can be used by investors learn about mutual funds.
My advice to investors is that they should take their investment decisions after making sure they are adequately insured first, have an emergency corpus and have paid off expensive debt. They should consult their financial advisers/distributors before making any investment decision.
While most of the services provided by distributors is intangible in nature, several studies have tried to quantify the value of this advice. A Morningstar study titled Alpha, Beta, and Now…Gamma shows that good financial planning decisions increase retirement income by 29%, which is the equivalent of generating 1.82% per year of higher returns. This is the additional value that can be achieved by an individual investor from making more intelligent financial planning decisions by engaging with their distributor/adviser.
Personally, I have a financial advisor who has been managing my investments for many years now. As you can guess, the trick lies not in the technical acumen that an advisor brings to the table (that’s a given) but the influence he can exert on my behavior as a long-term investor.
PGIM India MF has launched a new website for investors titled moneyandme. What’s the rationale and how is it different from other such websites?
MoneyandMe is an investor awareness initiative. The content is tailored for a range of age group from 18 years to 60 plus years. So, each segment of investor gets access to information which is bespoke to him/her. The site also provides many calculators to help investors estimate how much they need to save to meet different goals. The content is bucketed into 3 sections: Household Budgeting, Protect and Save & Invest so that investors get a holistic view of how they should go about planning their finances. Household Budgeting, Protect and Save & Invest are the three pillars that take care of your entire personal finance queries.
