Different people have varied opinions for investing, some have had a good experience and some bad and hence their opinions are varied. There is nothing wrong or right about having an opinion about things, most of us judge things based on our opinion but what is wrong is that we get biased towards them with a single experience. Here are five biases taken from the Organizational Behavior domain which fit here perfectly.
The 5 biases you must avoid while investing;
Anchoring bias basically means filtering all the information you receive through a common filter or sieve. A person who makes anchoring biased judgment is one who uses a single criterion or factor as the anchor and relates every other information to it.
In mutual fund investing, anchoring bias is the most common type of bias. Investors usually judge funds based on their past returns in order to estimate their future returns. In this case, the past return is taken as the anchor and selection of funds is done accordingly.
For instance, people who invested in mid-cap funds in the year 2017 through SIP method based entirely on the mid-caps past performance would continue doing so in expectations of over 18% returns. What they forget to consider is the fact that years like 2018 also come when mid-caps face a downfall. The big decision then to be taken is to continue that SIP or not?
An investor needs to rationally decide what he wants to do with his portfolio. Discontinuing a SIP when a dip occurs is not a wise decision.
As the name depicts, this bias is a self-blaming kind of a thing which occurs when an investor suffers from guilt after an investment decision did not prove fruitful. One needs to consider the fact that nobody makes a bad choice knowingly. All of us who push their money into the market do it in order to earn some more. It has been psychologically proven that loss causes more pain than happiness caused by gain. For instance, the pain of losing Rs. 100 on an investment is twice more intense than the joy of Rs. 200 gained on the same investment.
The loss aversion bias keeps investors away from a little risky but better rewarding investment avenues like equities.
The best solution to overcome loss aversion bias is to diversify your portfolio. Even if one of the schemes is incurring a loss, others will compensate for it.
The next in line is the choice paralysis which is basically the confusion you face when bombarded with a plethora of choices. A large number of choices increases the feeling of dissatisfaction. The mind is always focused on the road not taken and causes dissatisfaction in the mind of the investor.
You need to learn where to stop as information these days is available at your beck and call. Be it electronic media or print media or any other source, there is plenty of information and to top this is the fact that not all of it is reliable.
The best approach is to start eliminating keeping in mind your long-term goals. Focus only on the funds and schemes which fall in alignment with your life goals. This will eliminate a lot of unwanted options and make it easier for you to select the right funds.
Recency bias is the bias which is referred to taking an action based on the recent past. In mutual fund investing especially, this habit is prevalent in investors which makes them take decision based on a recent trend than the actual performance trend.
Recency bias leads investors into buying funds which have performed well in the recent past or are at their maximum valuations. This leads to a sudden and elongated dip in the fund valuation in the following time hence making investors wonder what went wrong.
Selecting mutual funds based on recent history is not the right thing to do. One must consider the actual trend of the scheme over the past some time and then make a decision accordingly.
Last but not least and the most followed bias is the Herd Mentality. The concept of herd mentality came from the herd of goats and sheep. The whole herd blindly follows where the watchdog or first sheep takes them. Similarly, in mutual fund investing, this kind of behavior is quite prevalent. Investors do not put their own brains at work in order to do some research on the funds and blindly follow what others are doing or say they are doing. What is worse is even if the personal view of an investor regarding investment is not so positive but since the whole herd is doing so, he does the same.
This herd mentality is so powerful that a lot of bubbles which have been created in the financial markets are due to this. The biggest driver of the mentality is the scheme-based investing or the rush to invest in rewarding but highly risky funds without conducting a background check. This ultimately leads to bubble-burst and red numbers in the portfolio.
Bias is an unavoidable factor while investing. A very few of us manage to get over all of these biases while investing but knowing that something like this exists is a step-closer to informed investing. While you look answers for other questions in your mutual fund scheme, do consider asking these three questions before- “When is the right time to invest?”, “What should I invest in?” and most importantly, “Why am I investing?”