How The Action Bias Trips Up Investors?

Your behaviours, perhaps more than anything else, will affect the long term returns that you’ll earn from your investments. A wide variety of literature on the subject of behavioural investing has led to increased awareness on the topic in recent times – but as any investor will confirm, knowing and doing are two different beats altogether! Perhaps one of the most common biases that plague investor behaviour is the ‘Action Bias’, or the constant itch to do something with your investments. Here are five common ways in which this bias trips up well meaning investors.

You Open a Trading Account

Amidst the throes of COVID-19, one thing thrived like never before – trading in stocks! Did you know that nearly 1.9 Crore new Demat accounts were opened in the 6 months between April and December ’21? Sadly, most of these accounts would have been opened with the singular intent of “Day Trading”.  - the ultimate manifestation of the action bias. In a nutshell, day traders necessarily square off their positions (either long or short) intra-day, which means they never carry positions overnight. Although this trading method is exciting, it is rarely lucrative and usually ends up losing money for traders – not to mention resulting in heavy transaction costs.

You Redeem Prematurely from Mutual Funds

It’s an unfortunate fact that the Action Bias is compounded by negative or poor returns. This is why even well intentioned Mutual Fund investors develop the itch to ‘do something’ with their portfolios when things don’t quite look up (as is the case for many investors today). Many investors redeem, imagining that they can ‘jump back in’ at a more opportune time. However, this almost never happens, and the hapless redeemer typically ends up sitting on the side lines for too long.

You Keep Stopping & Starting Your SIP’s

A lot of SIP’s tend to stop after investors have grown frustrated of poor returns over extended periods – only to sit on the side lines as stocks take off! In fact, SIP’s are a classic example of investors rushing into an investment product without a complete understanding of how it works. SIP’s, unlike fixed deposits, do not provide linear returns – ad history is replete with examples of SIP’s delivering low returns for extended time frames, only to gather dramatic momentum in a few years’ time – recall how 3 year negative returns from equity SIP’s in 2021 morphed into massive double digit CAGR’s within just a year! 

Checking your portfolio too often

Another all too common manifestation of the Action Bias is to check your portfolio too often. Remember the old adage – “a watched pot never boils”! In a way, frequent portfolio checking is both a precursor and a manifestation of the Action Bias. When you’ve invested in a portfolio of market linked securities, there’s no point checking your portfolio more than once every couple of weeks, or even better – once a month. That’ll give it sufficient time to smooth out news-linked aberrations and allow you to take more rational investment decisions

Getting flustered by short term negatives

Those who suffer from a prominent Action Bias are a lot more inclined towards getting flustered by seeing their portfolios slip into the red in the short run. The inability to stomach short-term negatives is actually a case of another behavioural fallacy known as the “Loss Aversion Bias”, and this invariably leads to the frustrated investor taking some purported “corrective measures” on their portfolio. No prizes for guessing that eight times out of ten, this turns out to be a regrettable act!