Avanti prides herself on her investing skill set and track record. But, on multiple instances, gets swayed by market volatility or news headlines and can’t stay true to her convictions in the long term. On the other hand, Rohan considers himself to be tech-savvy and sophisticated, so he tries to pick stocks that can beat the benchmark. But he lost most of his hard earned money in this shady ‘potential multibagger’ stock recommended by this influencer everyone has been following on Instagram.
If you are like most of us, you would have heard or seen these stories in your extended family or friend circle. If you have been investing for some time, chances are that you yourself have fallen prey to these behaviors- only to regret it later.
Human beings have developed certain instinctive tendencies & behaviors over time which have helped us survive till now. But, very often, some of these default behaviors hinder our investing journey. While these are useful psychological tools of survival gifted by nature, they can be roadblocks in your journey to long-term wealth creation.
But the good news is: you can be conscious about these biases and behave accordingly. Let’s take this quiz below to understand some key biases that we should be wary of.
1. You had zeroed in on this stock, but it keeps falling due to bad business decisions by the management . What should you ideally do?
A) Hold it for the long term hoping that it’ll bounce back while buying more of this share to average-out the losses
B) Sell the stock even if it’s at a loss, and invest in newer assets with better prospects
Many of us will choose option A, although B makes more sense from a logical perspective. We don’t want to lose money, so we fall in love with our investment and stick with it till the end. At times, we hold on to our poor investments in the hope that the tide will turn and we will earn a profit. Studies in investment psychology have also shown that the pain of losing INR 100 is psychologically almost twice as much as the joy of winning INR 100. This is a popular bias known as Loss Aversion. We need to be mindful of this bias and understand its influence in our investing behaviors.
Daniel Kahneman, who won the 2002 Nobel Prize in Economics, summarizes this well: “The concept of loss aversion is certainly the most significant contribution of psychology to behavioral economics.”. This is the reason many people stay away from wealth-creating assets classes like equity, just to avoid losing money.
Ideally, to avoid this bias, we need to establish a long term view on investing and need to ruthlessly follow a discipline of sticking to quality stocks. This means getting rid of investments which no longer make sense based on the new market conditions- even if that means selling at a loss.
2. A friend or colleague points out a flaw in your investing behavior? What is your default action?
A) You try to understand their perspective, and tweak your investments if it’s a valid point
B) You get cross at them, thinking that they are trying to judge you
We are blind to our own vices. Stuck in a virtual world boosted by self-confirming evidence carefully curated by the algorithms, we don’t often actively seek out how we can be wrong. And quite often, the external world also rewards this confidence. We flock behind this bold leader with all the answers who confirms what we already knew. So it seems very reasonable to get angry when somebody tries to pinch this bubble we’ve carefully created around us.
This tendency of humans to actively search for, filter and interpret information that matches our own preconceived notions and beliefs is known as Confirmation Bias. It gives us emotional & psychological stability by eliminating conflict & contradictions that may cause short term stress. But sometimes we pay the price in the long run. To avoid Confirmation Bias, actively seek out contrarian views: try to find what information you could be missing.
3. You see that everyone is pouring money into this new exotic asset you have no idea about, and booking huge profits. What would you do next?
A) You don’t want to miss out, and jump in on the train. We’re in it together!
B) You don’t invest until you have sufficient understanding yourself
If you find yourself choosing A most of the time, you’ve fallen prey to Herd Mentality. In simple words, this means to follow what everyone else is doing. And by definition we’ll get ‘average’ results if we always follow the popular trend in life, and don’t do our own research.
There is a reason Warren Buffett, the Oracle of Omaha, said: "Be fearful when others are greedy, and be greedy when others are fearful!". It’s very hard as well as time consuming to think on our own, rather than following the latest fad. To fight this, try to develop an understanding of personal finance. Do your own research and make decisions based on that information. See if it aligns with your unique situation and goals. Then only should you invest.
Successful investing is a long-term game which is not just about jaw-dropping returns, but also about risk management and survival. These are some of the many biases we must keep in mind to stay in this game and build wealth using the power of compounding. Be slow, steady, and look out for these behavioral biases, and let this resolve and temperament become your key to winning the investing race.