Five Behavioural Biases That Could Impact Your Mutual Fund Investing Experience In 2018
Regardless of what asset classes you prefer, your behavioural tendencies are likely to play a much greater role in your investing success than you think. It's a rather strange truth that each year, even the smartest and brightest minds fall prey to behavioural traps that severely impact their wealth creation potential. If you're a Mutual Fund investor, here are a few such traps that you need to be doubly watchful for in 2018.
The Sunk Cost Bias
A classic example of the Sunk Cost Bias is the case of Rahul Verma (name changed), who has been holding on to his investment in a Gold Linked International Fund for the past 8 years, in the idle hope of a recovery. Put simply, the Sunk Cost Bias prevents you from exiting underperforming investments just because you've already spend a lot of time holding them. If you've piled on the funds like there's no tomorrow, and find a bunch of them delivering consistently sub-par returns across long timeframes, it may be time to nudge them out of your portfolio and clean things up in 2018.
The Loss Aversion Bias
It's quite likely that 2018 isn't going to be a smooth joyride for Mutual Fund investors. We've got quite the tug of war going on at the moment. On one side, we've got rich valuations, the relative absence of robust earnings, global liquidity tightening and the threat of inflation. On the other side, we've got the prospect of bank balance sheets improving, infra spends picking up and capacity utilization rising. Without a doubt, volatility is on the cards - and you may find yourself in the unfamiliar position of being in negative territory soon after you've made an investment. In such a situation, you've got to fight the tendency to exit your investments as soon as they slip into the red - that is, the loss aversion bias. Nothing good can possibly come out of scuttling in and out of investments in the long run!
The Conservatism Bias
Are you bullish or bearish? Chances are, you've got a firmly entrenched view on the state of the markets as they stand today. In fact, 2017's stellar equity mutual fund returns may have made you so firmly bullish, that all you can think about is pumping more cash into equity mutual funds. Similarly, you may have formed a negative view of debt mutual funds in light of the recent rise in yields, and corresponding fall in their returns. However, do bear in mind that what goes up comes down, and vice versa. Don't subscribe too rigidly to any particular viewpoint, but rather let a solid, disciplined asset allocation strategy drive your investment decisions.
The Confirmatory Bias
Ever suffered from the confirmatory bias? You most likely have. A close relative of the conservatism bias that stops you from fluidly changing your viewpoint in response to changing dynamics, the confirmatory bias forces you to seek out information that corresponds to your own point of view. If you're bullish on equities, you'll seek out analysts that echo your viewpoint, while conveniently ignoring the naysayers - and vice versa. You'll actively seek out magical clues, chart patterns, forecasts and other titbits of information that bolster your confidence about your own opinions. However, 2018 should be the year when you drop this bias and focus purely on facts and data while defining your strategic and tactical investment decisions.
The Allurement of Stories
Last but not the least, safeguard yourself against the allurement of stories. Well-crafted stories have a near-magical effect on our decisions, and can drive even the most rational investors to make regrettable investments. The most striking example of how many hapless Mutual Fund investors succumb to this bias is the abject underperformance of most NFO's (New Fund Offers) compared to vintage schemes with solid track records of long-term performance. Despite this, investors continue to pump crores of rupees into new funds, as they're unable to resist the magnetising effect of a good story! Steer clear of NFO's in 2018 and build a portfolio of well established Mutual Funds instead.
