The key to better investing is to identify those biases and create rules to minimise their effect on their investing decisions.
Moneycontrol PF team
In this episode of Managing Money with Moneycontrol, we tell you about the various types of behavioural bias that impacts an investor’s decision making. In the accompanying video, Manoj Nagpal, Consulting Editor and Founder, Outlook Asia Capital, shares actionable insights on your portfolio that is, even if it is moving in tandem with the bull run, if not, chances are that behavioural bias is preventing you in making those profits. The key to better investing is to identify those biases and create rules to minimise their effect on their investing decisions.
What is behavioural bias and how it can impact an investor’s decision making
It is important to understand because when markets are at new high or when the markets are falling considerably what happens is emotions take over though investing is about making rational decisions but, you also remember that most of the time investments are also about emotions which are panic, fear, hope and greed. These are the four emotions that drive investor behaviour and these are reasons why most of the investors tend to take wrong decisions despite knowing what to do. When emotions take over most of the time people end up losing their capital. This phenomenon is knowing as behavioural bias and it impacts investors globally.
What are the different types of behavioural biases that one should know?
At this point in time, there can be so many emotional biases which can creep up. Let us know five different types of emotional basis which are very relevant for one to understand.
Recency bias: You make decisions about what has happened in the recent past. So this has actually played out in the last one year. The last one year investors have been buying mid and small-cap looking at the last one or two-year performance assuming that the same performance will continue in the future.
Action bias: When people start believing that they need to act on their portfolio, they need to trade on their portfolio on a more regular basis and that’s how they will create wealth but that is actually wrong, most of the time your returns will come on sitting on the portfolio and being patient and this bias can lead to more trading activity in your portfolio leading to higher cost and you may also lose out on the winners.
Single investment bias: It is a bias when a person starts looking at one small part of the portfolio rather than the entire portfolio. So you start looking at one stock or one mutual fund in your portfolio which may do well or not do well and you lose focus on what you other entire portfolios are doing. You should always be concerned about your overall portfolio return rather than looking at one single stock or one single part of your portfolio.
Herd bias: It is also known as the party bias. Most people when they meet their brother in law, or they go into a party to meet their friends and the friend tells them to invest somewhere they have the fear of missing out and the next day they start investing.
Loss aversion bias: When a person starts fearing that he will lose out either on the gains or on the losses. For example: At this point in time we are seeing that people can lose out on their gains.To know more on the behavioural biases, watch the accompanying video.