Three Behavioural Biases Investors Need To Watch Out For Now
It's a well-known fact that investor behaviour influences portfolio success rates just as much (if not more) that the ability to select the "right" investment, time the markets, and so on and so forth. Varying market trends tend to trigger different behavioural biases in investors - for instance, sustained bullishness fuels unbridled optimism, and extended bear phases tend to push many investors towards groupthink and excessive conservatism. The last two years have been an interesting time for both debt and equity markets, to say the least. After three years of excellent returns, debt funds finally turned bearish in 2017. At the same time, the picture for equities hasn't quite been rosy of late. As an investor, here are three behavioural biases that you need to be watchful of right now.
Loss Aversion
Did you know that research has proven that the pain of losing Rs. 100 is twice as much in magnitude, when compared to the pleasure of gaining Rs. 100? This is precisely why the loss-aversion bias tends to kick in firmly whenever portfolios slip into the red. This would ring true especially for late entrants who are trend-chasers - that is, they have a knack for getting putting on their dancing shoes just as the party's tapering off! Goaded by last returns, a number of uninformed fixed deposit investors jumped on board the debt fund band wagon in 2017, only for their confidence to be shattered. Ditto for equity investors who arm twisted their advisors into switching moneys from debt to equity in January this year! Now, with their moneys in the red, these very investors will be contemplating cutting their losses. However, this would be a mistake - at the very least, they should wait for they cycle to reverse (securities prices always move in waves) before rebalancing their portfolios, more in tune with their risk appetites.
Conservatism
Ever heard of the "conservatism bias?". It's the phenomenon wherein investors hang on to a pre-ordained point of view for dear life, even though that point of view may warrant a serious re-think. Real Estate in 2010-2011 is a classic example. While the indicators (over supply, high interest rates, oodles of unsold inventory) were pointing to a sure-fire correction, real estate aficionados continued snapping up plot upon plot, only to find themselves holding on to an illiquid, indivisible asset which hasn't really appreciated in price for more than half a decade! Not dissimilar is the case with those who earned outstanding returns from equities between 2012 and 2017 - after all, even the NIFTY index more than doubled in this period. However, instead of hanging on to the viewpoint that equity markets are still hunky dory, these investors need to face the fact that a lot of the tailwinds that drove this stellar growth have petered off in recent times, and a judicious asset allocation between equity and debt is the need of the hour right now.
The Action Bias
The Action Bias is the misplaced belief that "doing something is always better than doing nothing". After all, you may have earned flat to negative returns from your debt funds in the past five months, and your new equity investments may be marginally in the red right now. You'll be tempted to jump into action and begin taking steps to 'course correct' - only, this will likely see you slipping deeper into the abyss as markets are going to remain choppy throughout 2018. Many long-term debt funds that fared poorly last year may start to buck the trend this year, and equities may start to see a pullback rally just as soon as you attempt a 'tweak'. Instead of chopping and churning, have a plan and stick to it resolutely. Your plan should be based on your time horizon, your risk appetite and resultantly - your target asset allocation. When markets get stormy, passivity works a lot better then hyperactivity!
