One’s financial life is dependent on one’s financial/Investment behaviour. The way we earn, save, spend and invest is the result of our attitude and behaviour towards money. It is very difficult for an employee to start his own business, as he’s become habitual to a regular pay check. You can’t convince a spendthrift to start saving towards goals to make financial future comfortable. Many people are in a habit of only saving and not spending and there are those also who calls saving as investment. When we keep on doing one thing again and again, it becomes our habit and as the proverb says, “Old habits –die hard”. Once you become habitual to such behaviour, you resist change of any kind. You become so comfortable in it that you don’t want to change this habit even if it is leading to failure. Through this article I am sharing with you some of the Investment behaviour anomalies which every investor or anyone who deals in money for that matter should work on to get the best out of his finances.
1. Instant gratification
In the era of fast food, instant coffee and 2 minute noodles, we have become so restless that we want every solution instantly. We want the latest model of I phone whenever it gets announced, up gradation of car the moment we get salary bonus, buying brand new gadgets etc. without even realising the financial position. If we want it we’ll get it, doesn’t matter how. This attitude of ours has made “buy now and pay later offers” more popular. It increases the Credit card usage, induces us to take more and more loan which in turn puts so much burden on other goals that one ends up in a financial distress.
Basically instant gratification is all about concentrating on the immediate benefit, without realising its impact on our life later. In investments also, this behaviour is very common among people. We prefer stock TIPs than the long term approach of investing and wealth accumulation. Even if we have invested for long term, we still are more interested in the current growth rate of the investment. Some more examples of Instant gratification in the investment scenario are:
a) Avoiding Financial Planning, as this focuses on long term and doesn’t give the instant kick. (read: Ido(nt) need financial Planning)
b) Buying investment products just for tax saving and that too at the end of financial year.
c) Buying products like child Plans or pension plans, as it gives you the satisfaction that you are actually concerned about your future. (Read: plan your child’s future)
d) Entering stock market investments just to make immediate gain, without understanding the basics.
This Investment behaviour anomaly has to be understood in depth and should be fixed as soon as possible to actually gain out of your hard earned money. One should be more interested towards the process rather than outcome. As in the words of warren buffet, “it is only when you combine sound intellect with emotional discipline that you get rational behaviour”.
2. Risk Reward ratio:
While making investments, investor pays attention only to the reward portion. He sees what he wants to see. This behaviour can be judged from the fact
that equity participation was at peak in December 2007. We all know the short term risks of stock market but in 2007-08 every second person wants to enter in equity investments and all this was because of the booming market scenario. Everyone was so convinced with the India growth story that they were even withdrawing their PF savings to invest in the stock market, as the concentration was more on reward and not on the risk.
Same way these days’ investors are shying away from stock market and moving towards fixed deposits, why? Because they are again concentrating on the rewards and not risks associated with debt investments. (read : Bank deposits vs mutual funds)
One should always follow a proper asset allocation approach by understanding the risks and rewards associated with a particular asset class.
3. Availability Heuristics:
People tend to believe and act upon the most recent or more readily available information. Often, they start taking the recent past as appropriate representation of ultimate reality. Acting on the IT story in 2001, Infrastructure story in 2007 are some of the examples of this. Not only general investors, but many so called analyst and fund managers also are prone to this Investment behaviour anomaly and tend to make mistakes in the portfolio due to this. As many times one finds it difficult to go against the talk of the town. Media also plays a key role in this. When you get bombarded by the same news every day, one starts believing that. This is also called as Recency effect.
The best way to deal with this kind of investment behaviour is to stay focussed on your goals and stick to asset allocation. (read : stay focussed on goals)Once goals are fixed, focussed and investments are diversified across asset classes and sectors then you will be least bothered on the recent happenings.
4. Loss aversion:
We don’t acknowledge loss as much as gains. That is the reason we stay invested with the laggards but sell the winners soon. Loss aversion refers to the fact that people are more upset when experience losses as compared to the satisfaction they derive from similar gains. Let’s take an example to understand this. 1 year ago you have purchased 2 stocks A & B for Rs 50000 each. Now after 1 year stock A is at Rs 60000 and stock B is at Rs 40000. Going ahead fortunes of both the companies are not looking bright. What would you do? You will sell Stock A immediately, but will wait for Stock B to recover, as you don’t want to book loss. You might also buy more of stock B to average the cost of purchase. This is due to the Investment behaviour anomaly of loss aversion. It might have been better to sell both stocks immediately even at loss and invest somewhere else where the prospects to gain are more, but since you don’t want to acknowledge the loss you like better to bear the opportunity cost. These mistakes are common with insurance policies, where people come out of ULIPs but continue with the Endowment policy, just because the latter will bring into more monetary loss.
One has to learn to deal with this anomaly, as with the volatile nature of stock market and also the obligatory nature of investors, you will find such situation now and then.
5. Herd Mentality:
We as human beings feel more secure in groups. We avoid going against the crowd. Even if we feel that our decision is right still we look for confirmation of different people. We buy and sell what and when others are buying and selling. If our group is not in favour of something, we tend to behave in the same way. You can find this behaviour among group of friends who has done same kind of investments, purchased same insurances and that too with same sum insured etc. This gives us the confidence that if anything goes wrong we are not the only one’s affected. If we have done something against our group’s views we search for a separate group where these gets accepted and thus find solace that you are not the odd one out.
One has to realise that every other person is different and with different risk appetite and needs. There’s no “One size fits all” strategy in financial planning. So where following the herd gives us the satisfaction there it is not the right way as far as finances are concerned. One should have a logical reasoning towards a particular financial decision.
I know that this is easier said than done to improve onto such behaviour issues, but I also strongly believe that a structured approach like financial planning will surely help you in this. When you are more focussed on goals, follow a proper budget, understand your debt servicing ratios, allocating investments as per the time horizon decided and diversifying it across asset classes and sectors you make the process of investing simpler and easier to adapt and follow. If you manage your investment behaviour properly, your investment returns will automatically get managed.
Nice article. I totally agree with you on loss aversion and risk reward ratio. Infact i feel that both these are inter related. We don’t acknowledge the loss, because our focus is towards reward only.
[…] rest Rs 8 lakh you will have to arrange yourselves. Just to satisfy the immediate gratification ( Read :work on your investment behaviour), people tend to look out for personal loans or gold loans to arrange for down payment, but this […]
[…] with properly, if someone is seriously interested in improving one’s financial situation (Read: Work on your Investment Behaviour). One of the major behaviour risk/anomaly is Instant gratification. Basically instant gratification […]