Zee Business Money Guru 21 Dec 2015 , Prakash Ranjan Sinha Director, N...

Investor Biases and its effects in Investment decision making

 Investor Biases and its effects in Investment decision making

•       Status Quo Bias

Here the person does not do anything . He tries to maintain the same and let the things be or happen as it is. The person does make no attempt to make any change. Happy with what is going on. He fears the change for negative result or bad experience or loss. We try to eat the same dish and are averse to try some thing new for the fear that it might taste bad.

In Investment the investor with this type of bias stays with a particular fund or product as has been having good experience . Even if the market dynamics changes or performance of that product goes down still he continues with it . Investors need to rebalance at times and get away from product or fund. By not taking any action at times that investor might continue to be in losing fund or also losing opportunity of enhancing the return from better performing product.

•       Familiarity Bias

Each one has a perception about any product . The perception at times are influenced either by our near and dear ones or by advertisement to a large extent . Sometimes it is due to own experience also . Whenever he is going to buy a product this bias plays into his mind and it influences his buying decision . He at times does not evaluate other options or overlooks them even if they are better.

In investment if some one has seen his close friend investing in a particular fund . People have a tendency to follow what their close friend or relative has recommended. This may not be right at times. Each individual is different and so can be his need or requirement for money . Also if some one has benefitted in past does not mean the same stands true for you also as situation might have changed .

If you yourself have invested and got good experience you will tend to be over invested in it and so carry over exposure or lack of diversification risk .

•       Narrow framing Bias

Sometimes when we take any buying decision we just look at a one or few factors . We don’t evaluate in totality . Get impressed with one factor and don’t even bother to examine other factor or feature and buy the product .

In Investment one has seen every time one is investing he is concerned with loss of capital and volatility and ends up in safer debt product..Yes safety is important but you can not have your overall portfolio in debt only . The other extreme could be getting impressed with short term performance and buying that product . Again the biggest risk of this is concentration or lack of diversification.

•       Overconfidence
Investors believe that their decisions are superior to those of others and, as a result, they are more inclined to make risky investments. This happens if the investor has taken some decision and that proved to be correct. Investor having such type of bias always tends to give credit to themselves for good result and put the blame on luck or something else if result goes bad . they don’t own the bad result also .

•       Myopic Loss aversion
Investors may feel losses more keenly than gains and may therefore sell loss-making investments more quickly. These are the investors who are more concerned by short term losses than long term gains . They get perturbed at small notional losses . Even if they know that the fund is good in long term and has given good return in past and has sound portfolio also but they are so sensitive to immediate notional loss that they get out of the fund . We have seen many such investors when market not doing well . One should protect the value of investment only when he is near to his goal or liquidity requirement . If the requirement time is distant he needs to have patience .

•       Recency Bias
Investors tend to put more emphasis on the recent past when making decisions about the future, expecting that the future is more likely to look like the recent past. This is also known as “anchoring”. Many times people invest in those funds which are winners in short term or leading the pack at that moment . Yes one should invest in good funds but again good return is also subject to risk the fund has taken either in portfolio or fund management . Are you ok with that risk ? Generally one has seen investors selecting fund which has done very well in recent times . Rather than this they should look at fund which has been consistent in long term and least volatile in recent terms. Recency bias at time make people to move to fund with higher risk e.g from large cap to mid cap fund during bull run.

•       Disposition affect
Investors sell their ‘winners’ too early, but hold on to ‘losers’ for too long. This type of investors recognize gains more than the loss. Sometimes they feel why to sell at a loss. Let this recover its face value at least and tends to hold on. They feel already reaped the benefit and gain and sell the winner rather than cutting the loss . In fact they would be better selling loss making investment as that will benefit them on capital gain ( loss here ) tax benefit . Sometimes investors tend to look at the quantum also while evaluating which one to sell and feel satisfied if they have sold gain making investment and held loss making ones .

•       Information Bias

Today we are flooded with variety sources on news and views . It comes from newspaper, internet , facebook , whatsapp , blogs etc . Not possible that we can read all and have a fair judgement . The message in all such communication may not be fully fair . Chances might be of bias , prejudice or incorrect comprehension . General tendency is always to over emphasise the bad and negative news and the over emphasis is not in case of good news . Negative or bad news get imprinted in our mind and plays havoc for larger portion of time . We have always seen that in the case of equity . The impact of bear run or bad return and news related with it last much longer in the mind of investors . Don’t read lots of news and views and get your mind confused . As a precaution read news , views and analysis from credible unbiased sources only . Don’t believe blindly and form a opinion. Do your own cross checking before selecting or rejecting a fund .

·         Confirmation Bias

Every one has his own view and opinion. In this bias people favour and support that view that matches theirs and reject that does not match their views. Sometimes people only seek for such views . This type of bias stops them being analytical . It can also make them to take investment decision in hurry and not complete check-up . Many people form certain myth and take investment decision on that if they get some support from any one else. They feel they are correct which may not be true always. The worst part is that in case they get benefited by luck then they try to follow it with greater belief . Investment in stock or market timing is common case of such bias . Valuing their own short term , lucky or unlucky experience becomes the basis of selecting and rejecting any fund.