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.

Investing in Equity Mutual Fund is like taking a journey in a Taxi

Investing in Equity Mutual Fund is like taking a journey in a Taxi 

You must be finding strange at the above caption. Must be wondering what is the correlation between the two and how the two are comparable . Sometimes we understand a thing better if linked with some  vivid experience .

Let us assume I want to take a cab from Delhi to reach Agra . What are the things I am going to look at before selecting and going for the journey .

How quick and safely I can reach my destination .  I can not be unreasonable to think that a 4 hour normal journey will be covered in 2.5 hour or also not be accepting that it should take 6 hour . I have a realistic time expectation as to when I will reach . If I have targeted a particular time to reach I should start at right time. I don’t want to go slow and be late .But at the same time I might not be in hurry to reach as quick as possible  taking unnecessary risk but if I reach before time safely I would be happy.  In Equity MF investment like reaching Agra my long term goal could be  children higher education ,marriage, post retirement etc . I have targeted a level of return to match my cash flow requirement so must get that much at a right time. I should start investing well in time or have a realistic time horizon where I know I will get my desired return.  My expectation of return has to be realistic but in case I get more than what I realistically expected I would be happy .  

In our cab drive we know and are mentally prepared that at some places we will see heavy traffic and speed will be slow but also know that there will be places where car will speed up and earlier time loss will be compensated . Similarly in equity fund we should be mentally prepared that in between in short time duration sometimes return might be low as condition might not be favourable but again there will be good market scenario also where opportunities for earning higher return in the fund will come and earlier short term low or less return will be recovered .

Roads might be bumpy at some places and some place smooth . I want a smooth ride so expect the cab driver drive with caution at potholes and speed where smooth. Stock Market is also bumpy and we expect fund manager to protect downside when market is falling or volatile and when market moving upward take advantage of the upside . The overall ride is mix of both experience but the total experience ends up well and happy . Just like we expect cab driver to balance his overall drive looking at road condition we should expect the same from equity fund manager looking at the market condition and opportunities available.

Even if the car goes slow or some one overtakes it we do not change the car and shift to fast moving one  . Once we have decided after thorough diligence about the cab and driver we trust him and ride in the same car . In case of equity mutual fund also once decided after doing all analysis and diligence we do not keep on shifting between funds due to short term performance . In short term there will one fund overtaking other like cab but if we have conviction and evidence that the fund will deliver as per our expectation we continue invested . We can shift from one fund to another only when it becomes a non performer and something serious wrong and no corrective action being taken similar to when the car goes for a breakdown and change becomes imminent.

We might look at the cost but again for the sake of low cost we do not compromise on comfort and other thing . In equity mf investment also the cost has less relevance if that gets compensated by better return .

We look at the cab driver . If he is new we might be a bit hesitant but if he is experienced we don’t hesitate . Again when one is selecting a equity fund the experience, expertise of fund management also needs to be looked before making an investment decision . In a cab you don’t know from where some rash driver can hit you , suddenly caught in traffic jam and at times driver take diversion route ,don’t know when the car ahead puts brake and your driver need to be alert to put brake in time etc . Similarly equity investment is subject to so many risks , market risk , company risk , business risk etc and a skilled prudent fund manager is expected to manage all risk to see that the portfolio is least hit and damaged . He has enough tools and research based inputs which helps him to tackle various risks .

We do evaluate the interiors, comforts , speed , seating comfort .  That makes the ride happy and peaceful. Similarly when investing in equity fund you look at asset quality , the various options , systematic approaches of investment , transfer and withdrawal, payment mechanism these provides you advantages over investment avenues .

Winning Investment Strategy

Winning Investment Strategy

Lets look at some of the facts

·       

      Generally a youth starts earning at approx 23 years of age , normal retirement is approx 60 and with increasing longevity can live up to 80 years of age . It means approx 37 years of salary earning and 57 years of survival on total earning of which last 20 years when there is no fixed monthly salary earning .

·         Historical returns for a 1 year, 3 year or 5 year debt fixed return investment product has been between 8% to 9% . It might have gone 1or 2 percentage during higher inflation in past . When one looks at equity return the range could be any wild guess in short term positive or negative ( 1 year or less period ) but as one moves to longer period some pattern of fixed return emerges and from period 5 years onward the return has been generally higher than debt return and in the range of 15-20 % . Moreover the probability of getting expected higher return increases with time duration and it is almost 99% for 10 year and above investment horizon.

·         If we track bank deposit rate for 1,3, 5 and greater than  5 year periods one has seen that there is no extra return for greater than  5 year period investment . At times 5 year FD return is less than 3 year FD and also return on 5 year FD and greater than 5 year FD are same. It simply implies that there is no extra incentive for investment beyond 5 year investment .

·         In India the investment of individuals ( households ) in debt vs equity is approx 96: 4 i.e only 4 rupee out of total 100 rupee invested is in equity ( share or mutual fund ) and 96 rupee in debt ( bank deposit , fixed deposit, post office deposit etc ) .  

Lets look at investor attitude toward investment . Do they want return OF investment i.e NO LOSS or Return ON investment i.e GAIN. Off course first one is the basic minimum requirement which everyone wants .  Now we need to understand NO LOSS also .Is it capital getting back ( i.e if 100 rupee invested then should get back 100 at least ) or todays value worth of Rs 100 when invested which means taking account of inflation i.e if inflation has been 7% p.a then at least get Rs 107 after a year of investment .

If I look 96: 4 ratio ( Debt : Equity ) I feel most are satisfied with protection of value of money invested . Anything marginal above it is more welcome .  But question is how much more they can get .

Lets try to understand why there is no incentive for long term investment in bank FD . Bank deposit rate is based on repo rate which to a large extent is based on inflation rate and also economic growth ( GDP ) requirement . Bank rate can never be less than inflation else why some one will deposit to lose its money value . But at the same time as we are growing economy and there will be demand for money i.e loan requirement so Bank Loan rate has to be as less as possible . Competition and demand for loan decides bank deposit rate and bank loan rate .

So the best return one can expect from fixed deposits of Bank is few percentage more than inflation rate . It implies there is RETURN LIMITATION in debt investments .

The MINIMUM return from debt any investor looks is return OF investment where net return is positive i.e inflation growth is also taken care . This is the normal mindset . Why not ye dil maange more .

Every investor if desires MORE than this ABOVE MINIMUM but with no disturbance of peace of mind then he has to look where there is ZERO probability of return not going down from the MINIMUM . It means he has set a base return + more which is return ON investment .  When looked from debt perspective It has to be from where there is no extra incentive for debt investment ( i.e  5 year ) . It means if investment horizon is beyond 5 year investment asset should be in equity and not debt . Cross checking the same in equity investment i.e from where the 99% probability of base return + more starts it is 5 year .  The more the time horizon beyond this there is probability of higher consistent return in equity.

If wants to ensure more SAFETY AND STABILITY i.e more assurance from downside risk from equity investment one should invest through mutual fund route where research based investment decisions are taken and also diversification in many sectors and stocks reduces volatility in return .

Zee Business Money Guru 02 Nov 2015 Prakash Ranjan Sinha Nurture Indi...

Understanding Return in Investment Products and Risks affecting the Return

Understanding Return in Investment Products and Risks affecting the Return .

We all invest in various investment products .Debt , Equity , Physical Gold and Real Estate are the main assets for investment in India . Everyone wants good return but at the same time does not want any loss . So it is very important to understand how return comes and from where the risk i.e possible loss can come .

Return comes in two form – Regular and Capital Gain . In case of Debt the regular part is Interest Income, in case of Equity it is Dividend income . In case of Real Estate it is rental income. Gold does not offer any regular return if invested in pure physical form. Capital Gain booked when you sell the investment and the gain coming out of difference between purchase price and redemption price forms Capital gain.

Lets take example of Debt .

Return == Interest + Capital Gain.

The risk associated with interest rate i.e may not get interest comes from the credit quality of the company where one has invested . Generally if you invest in good investment grade paper the risk of not getting interest does not exist. So within investment grade also return component from interest gets enhanced by moving from AAA rated to AA+ or to AA or to AA- . The second return comes from capital gain i.e when you sell. This is affected by the duration of the debt securities and the impact of change in interest rate scenario in the economy . If general interest rate goes up you will get capital gain but in case general interest rate in economy goes down there might be capital loss . If the term to maturity is less the impact of capital gain or loss will be less and if the term to maturity is more the impact of capital gain or loss will be more . So the risk to your return component from capital gain side is mainly due to trend in general interest rate movement .

The best way to look for return and also manage risk is to get debt mutual fund product . In case of rising interest rate scenario your investment should be into short term fund or floating rate fund having investment grade securities . In rising interest rate scenario Fixed Deposit and Fixed Maturity Plan are also an option . In falling interest rate scenario  be in long term debt fund or in a duration fund where the fund manager is increasing or decreasing the maturity of portfolio by shifting from short term debt securities to long term debt securities and vice versa. One thing any investor must bear in mind that due to higher tax rate investment in debt in any form reduces the net return post tax . You get some indexation advantage if done in debt mutual fund and the stay is long period (more than 3 years ) .

Lets take example of equity .

Return == Dividend + Capital Gain

Dividend is paid from accumulated net profit . It also depend on the company policy i.e. whether they want to plough back profit for business growth and expansion or want to share with shareholders . So the risk of not getting dividend here comes if the accumulated net profit is inadequate and/or the company policy on dividend distribution . On Capital gain side risk of making abnormal gain or loss emanates from time aspect , economic scenario and quality of asset ( market cap of security ) . In short term all equity securities prices are affected more by piecemeal news and views associated with that company . This news and views may be a fraction of company’s total related information but it creates an impact even for few days. If economic condition is good or stock market rising then even in short term there are more gains than loss . Large cap stocks again rise slowly vis a vis mid cap stocks if stock market is rising but they fall also slowly vis a vis mid cap when stock market is falling . Analysis of piecemeal news and views is not an easy job for a layman . How those things will impact the price and for how long is definitely not a layman cup of tea. So when some one invest directly in stock first mentally he should be prepared for this . Secondly he should have some authentic professional guidance on stocks where he is investing . Your gain or avoidance of loss depends on how quick you respond to price change and also quality of holding . Short term direct equity investment adventure have been loss making result for most . Some of the risk that can affect your return is ( a) selection based on temptation or herd mentality ( b) If trying to time the market end up being less proactive to get in or get out of a particular investment at right time . In long term if the stock you have selected is good one it will give you good capital gain as in long term net earnings of the company gets properly correlated with the price of stock .. The best way to mitigate the temptation risk , time risk, stock selection risk , lack of proper understanding etc is best managed by investing through Equity mutual fund where research based investment decision making is done and the portfolio is constructed keeping diversification aspect so that over all portfolio risk is minimised. Portfolio is managed both with stability aspects i.e investment in good businesses  and also encashing on opportunities provided in short term due to price volatility .

Gold presently look to give capital loss in short to medium term. Yes if someone is linking it with need based ( for marriage , gift etc) after 10 years from now then he can look for investing in Gold ETF through SIP ( Systematic Investment Plan ) . The proportion of Gold should be 5-7 % of overall portfolio value in all economic scenario . Gold has very less reproductive value and its price movement mainly depends on demand supply factor . Supply side has limitation but demand will grow either for investment reasons or sentimental reasons or family function compulsion reasons .

Real Estate is good and has given good returns but again has liquidity problem, requires large corpus for investment . One risk is at many places the price has almost stagnated last few years so one needs to evaluate the location risk . Real Estate investment is good when one does not require money in short to mid term and also enough other liquid investments ( Debt/Equity/ MF) to take care in case money is required. Else the notional return i.e return on paper is inconsequential in real terms as it is not going to help you when you require money for meeting some important need .

So pl always remember Investment is nothing but deferred consumption and fine balance on Liquidity , safety and return to be made as per your overall need and requirement.

Market is jittery so what the Mutual Fund investors should be doing ?

Market is jittery so what the Mutual Fund investors should be doing ?

Last some days Indian stock market seeing some big downside followed by some small upside and then game of upside , downside continuing . Reasons are Chinese and US market impacts about which we can do nothing . What will be happening is days to come , how long we will see the volatility , Is there more fall expected in market levels etc , these questions must be coming in the mind of Indian Mutual Fund investors . Experts have been airing their opinion . I have always held a view that these opinion on market levels in short to mid term are very difficult to predict . My observation has also been that looking at last very few days trend and news these experts air their view . How far they prove to be correct on continuous basis is again something which has not been always proved with full accuracy . My concern is not about market levels or experts prediction but what’s going in the mind of Mutual Fund investors and what their mindset should be .

Firstly when we say Equity MF is a long term investment i.e must have a minimum investment horizon of 3 years plus or 5 years plus ( for those who are more conservative ) it means that the short term volatility risk is well covered in this minimum time period . There are two type of transaction happens – first you invest i.e buy units of the equity mf scheme selected and after more than 3/5 years you redeem i.e encash your units purchased .

One mistake which most investors do is when they buy they look at market level or at least influenced by the rising market level and when they sell either it is due to need or to book profit or may to save the loss if market falling . Investment in Equity MF looking at market level is the wrong approach .

I will give you an example of onion which had caught the attention of whole India due to rising price. Suppose onion is priced Rs 6 per kg or Rs 60 per Kg or Rs 200 per kg . Does this changes the quality of onion or the taste of onion ? Definitely not . I might be buying less or more due to price but quality or taste is independent of it . Price is affecting my buying behaviour  . The benefit in terms of taste that the product gives is independent of the price. Lets assume in above example that price is reducing ,then will you buy less or more onions ? 

When you are investing in MF again market level or NAV is something which can affect you psychologically but you must understand that you are investing for the coming benefits i.e the growing earnings of the companies where fund manager has invested on your behalf . It will never happen that companies are growing in terms of earning and its market price will not grow . So in long term with rise in valuation of companies  stocks which are in portfolio , NAV will grow and so will grow your return. Generally most of the money invested by fund manager is with mid to long term view and some / few with short term view where he wants to take advantage of price/market volatility . What should affect you is the quality of portfolio or earning ( profit after tax ) generation capability of the companies . If that is what getting affected then yes there is a point to worry . If the earnings of the company is externally determined rather than internal ( domestic ) demand then yes some area of concern as investor . But even in the worst of recession situation ( 2008-09 ) we did not see any downswing in consumption patterns in India . When our economy is consumption led economy then the industries /companies catering to local demand will be less affected .

Indian investors who are investing in equity MF schemes should not worry about market levels as that reflects the instant buying and selling behaviour of the market participant which is in no way related to the earnings of companies . Ultimately as MF investors you will gain till earnings keep growing so be calm and stay invested . Don’t get affected by short term views of experts . It is more for day traders in equity and not for long term equity mutual fund investors .