4 behavioural biases that negatively influence one’s capability to spend money on and methods to keep away from them

Today it feels that everybody is a Jhunjhunwala, but when that have been the case, all traders could be residing in sea-licking, multi-million-dollar mansions. It is essential in these occasions to maintain a stage head and a cool thoughts and keep away from the quite a few biases that go away us nursing our wounds when the bears come out to play.

As the Bhagavad Gita so succinctly reminds us, “For the one who has conquered the thoughts, the thoughts is the perfect of mates; however for one who has failed to take action, his very thoughts might be his biggest enemy.”

Let us then decide to be friends with our minds by overcoming our biases when it comes to investing. Some of the more prominent ones that we fall for are:

Herd bias coupled with recency bias: Piling into flavours of the month along with everyone else – from the FAANGS to the HRITHIKS, to AI stocks or Crypto may leave one in a dangerous position and vulnerable to bear attacks. While they may be great companies or opportunities with a strong history of building wealth, they may not always be available at great valuations.

Just because a certain investment has done well for a period of time, does that mean that it will continue to do so? There is always constant disruption, business cycles or valuations that require the greater fool theory to play out. Apple may be a great company, but does everyone’s pensions depend on it growing at the same pace in perpetuity?

We need to independently and constantly keep reviewing our positions and themes to ensure that we are not over-anchored with biases of yesteryear.

Stereotyping coupled with vicarious bias: A dangerous combo – often I hear my mother giving me advice on what to invest in based on her stock picks from her relatives. The age-old adage of “always listen to your mother” in all probability doesn’t apply right here.

First of all, she didn’t do any work to grasp the corporate, the sector and even the valuation and secondly, it is in all probability in an area that has garnered her curiosity that sounds “thrilling”. After all, everyone uses the internet or needs toothpaste.

But let’s face it folks, this investment technique doesn’t scream of success. Yet, it is something that one hears of people investing through hearsay all the time without doing any real research.

The market will test your conviction, either by showing you violent red, or simply keep the stock stagnant for extended periods of time until you get investor fatigue and throw the towel in. As a contrarian value investor, you sometimes need the ability and stomach to stay underwater for years until the story plays out. “Borrowed conviction” and “cursory information” will only get you so far, but one needs to be firstly able, to understand the company and secondly, be willing to get into the trenches to ensure that when the guns are blazing.

Overconfidence bias: When the markets are riding high, we can all be guilty of feeling overconfident and thinking that we have become George Soros. We become reluctant to take money off the table and everything we invest in, we believe, will become a multibagger. Clearly, this is not so. And a contrarian nature, even on the way up, is required.

Loss aversion bias: On the flip side, there are people who avoid investing in stocks altogether. Humans by nature are hard-wired to avoid risk because the pain of the downside is more prominent than that of an upside. It generally stems from the time when our ancestors, upon hearing a rustle in the bushes, were faced with the option of “fight or flight”. The extra wise choice appeared to be flight on condition that the draw back danger may have been ending up as a sabre-tooth tiger’s dinner.

Thus, centuries later, some folks relatively play it protected and maintain their extra funds within the financial institution, bonds and different protected however low-yielding merchandise. But clearly, once we look over time, equities outperform most different asset courses so long as one is prepared to simply accept and take in volatility, which hopefully is only a notional loss. Although on the time when seeing all that pink, it does really feel fairly painful. But in avoiding a correct asset allocation, they’re more likely to at all times sit within the shallows not letting their cash work for them.

It is difficult to beat these biases, however it’s advisable to maintain a average thoughts and keep away from being grasping by taking cash off the desk in a measured method thus de-risking one’s portfolio. One needs to be prepared to place within the groundwork to grasp an organization’s intrinsic worth as that might be your anchor when the tide turns.

Arun Chulani, Co-Founder, First Water Capital Fund.

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Updated: 16 Nov 2023, 03:01 PM IST