In the Indian stock market, it is quite usual to see investors stuck in a tug-of-war between their analytical thinking and emotions. Your research is saying ‘hold’ but somewhere your panic-stricken mind is saying ‘sell’.
“The investor’s chief problem – even his worst enemy – is likely to be himself.”
- Benjamin Graham
If you were to rely on analytical skills, then it is as easy as devising a right statistical/quantitative strategy, prepare various valuation models, and you would be all set to invest in a business.
Alas, human emotions don’t allow us to follow this. In normal cases, an investor gets jittery when the stock price falls. Driven by emotions, an investor pushes the sell button at the first sign of market fall without understanding the consequences and reasons behind the downfall. And thus the vicious circle of emotional biases begins from here...
Howard Marks, a billionaire value investor, said more than two decades ago, “In order to be successful, an investor has to understand not just finance, accounting and economics but also psychology.”
Let’s take a look at few investing biases that affect the performance of the portfolio:
Some investors believe they can successfully time the market by predicting market downturns and rallies. This leads to frequent buying and selling which reduces the returns because of the costs involved.
Such investors often forget the times they were incorrect or recognizing the role luck played in positive outcomes.
Investors are bombarded with lots of irrelevant information every day, from business channels, newspapers, social media, friends and acquaintances. At times it is difficult to filter through it to focus on information that is relevant.
Many investors believe that they have a knowledge advantage when they get a tip from someone but unfortunately, end up with the wrong investments or sell sound investments that have further growth potential. Successful investors see the ‘wood from the trees’ by looking beyond the daily share price movements. They rather focus on concepts such as ‘Margin of safety’ on the basis of the moat that a company enjoys.
Following The Trend Bias:
Many small investors are heavily influenced by the actions of others around them. If everybody around is investing in a particular stock, there is a strong tendency to do the same. But this strategy is bound to backfire in the long run.
Legendary investor Warren Buffett has rightly said, "Be fearful when others are greedy, and be greedy when others are fearful!" He became one of the most successful investors in the world by resisting the bias of following the trend.
Loss Aversion Bias:
People often feel the pain of loss more than the happiness of profits. Loss aversion is one of the most common investing mistakes. Investors are most likely to sell stocks that are increasing in value but will continue to hold businesses that are falling because it hurts to take a loss. This strategy results in a portfolio composed entirely of shares that are losing money.
Many investors tend to suffer from self-attribution bias where they take the credit when things are going good and attribute it to their stock-picking skills but blame luck for losses due to wrong investment decisions. As a result, they end up committing the same mistake again and again.
‘I know that would happen’. Who hasn’t used this line or heard that? Hindsight bias tends to overemphasize/ overestimate the accuracy of one’s own predictions and that can have perilous effects on your portfolio.
Investing based on your bias in equities should be a strict no. You should invest only based on facts and data backed by thorough research. I agree that overriding emotions is a difficult task, but not an impossible one.
America’s famous investing and personal finance columnist Jason Zweig once quoted, “Investing isn’t about beating others at their game. It’s about controlling yourself at your own game.”
Successful investors have done that and that is the only way to create sustainable wealth in the long run.