Moneycontrol PRO

Volatile markets: Time to overcome our emotions

Various behavioural biases have made investors lose money, or not pocket the return they should be getting. Here is how to overcome these biases.

February 19, 2016 / 09:41 AM IST

Tarun BiraniTBNG CapitalBuying when market is at its low is like buying in a sale, but a stock market sale usually makes investors jittery rather than excited!!!!! More than stock market volatility your emotions can adversely affect your portfolio. These emotions in financial language are called behavioral biases, wherein your brain lures you into investment trap. Behavioral finance experts have identified various common biases that affect investing decisions.Trap 1: Confirmation BiasConfirmation bias is the tendency of people to favor information that confirms their viewpoint and belief, subsequently ignoring information that goes against their belief whether it’s positive or negative. Confirmation bias suggest that an investor is more likely to seek for information that supports his own belief & would make investment choice based on these one sided information rather than seeking out contradicting information & making a fair analytical judgment.For Example: Investors have the tendency of considering equity market highly volatile & thus based on these one sided information they avoid making investments in equity because they only see the short term volatility & avoid the complete picture of its potential to deliver long term return.Feasible solution:To avoid confirmation bias before making any investment decision, investor should analyze all pros and cons of an investment avenue. Trap 2: Worry BiasThe act of worrying is an ordinary and widespread human experience. Worry increases anxiety while taking an investment decisions. Too much worry lowers the level of risk tolerance among investors. For Example: When markets are at its bottom you might be saying yourself “Maybe the markets just aren’t for me” & sell all your holdings, booking a huge loss without analysing the long term prospects.Feasible solution:To avoid worry bias investors should match their level of risk tolerance with an appropriate asset allocation strategy by consulting a financial advisor and should undergo a risk profile test before investing.Trap 3: Familiarity Bias People have different perception towards different brands, these perception are usually built because of their familiarity with different products associated with that brand. When it comes to investing investor usually selects the asset class he is familiar with.For Example: If you have seen more of your families investment routed towards fixed deposit, even you are tend to divert more of your investment towards fixed deposit. Feasible solution:To avoid familiarity bias investor’s portfolio has to be diversified into different asset class like equity, debt & real estate. Again in each asset class the portfolio should have adequate strategic diversification which would help to reduce short term volatility & make your journey towards long term wealth creation smoother.Trap 4: Anchoring BiasAnchoring is a concept in behavioral finance where a person’s decision making ability is anchored by some past event. For Example: An investor today stays shy of investing because his mind is anchored by the 2008 stock market crash. He just cannot think beyond.Feasible solution:To avoid anchoring bias in investments our decisions should always be future looking and we should steer clear of past events. Make investments on the merit of investing principles such as long term investing, asset allocation and diversification etc.Trap 5: Bandwagon Effect Bandwagon effect means following others. Doing the same thing or taking the same decision as everyone else is. But a person’s investment decision should be based on his individual situation, investment horizon, and risk appetite.For Example: There is an upcoming IPO of XYZ company. Investor has no independent views on the prospects of the company, nor done any research on the same. But he has heard too much noise about this IPO in news, through friends etc. As everyone is highly talking about this IPO he ends up investing in it. This is because of “Bandwagon Effect.”Feasible solution:To avoid bandwagon effect your portfolio decisions should be based on your individual situation, investment horizon, and risk appetite. Try understanding what your money is put to & take an informed decision.Conclusion:This investor behavior is aptly captured by Benjamin Graham in a saying “The investor’s chief problem and even his worst enemy is likely to be himself.”Some of the behavioral bias discussed might have served us well in our regular life, but they may not be helpful for achieving long - term success .Though there are no precise solution of these biases but as an advisor I always encourage investors to be aware of these biases & their effect on investment with a view to help them in making better investment decision.