Friday, Dec 01 2023
Source/Contribution by : NJ Publications

Investing should be a logical thing and rational thing. Quite often, long-term investing success is more closely linked to our behaviour and our decision-making framework than anything else. Over the years, this has played the most impactful role in the outcomes. Unfortunately, often emotions and biases play the spoil-sport and influence our decision-making. While emotions can be managed to a certain extent, the biases are more difficult to handle. We may think and believe that we are acting rationally but in reality, even our rational thoughts and decisions are unknowingly influenced by our biases. Thus, it becomes necessary to identify and understand these biases so that we can mitigate their impact on our investment behaviour and our rational decision-making ability. 

In this article, we will explore 10 such common personal biases that can impact our decision-making:

1. Illusion of causality: 

We have a general tendency to see patterns and connections where none exist, leading us to believe that one event caused another. For example, an investor may believe that past returns will continue to accrue in future because that is how it has been for the past few months. We unknowingly create the bias for or against based on patterns and connections that we create in our minds. 

2. Anchoring effect: 

The anchoring effect is the tendency to rely too heavily on the first piece of information we receive when making a decision. For example, an investor may come across good news on some investment opportunity and develop a preference for the same despite successive more important negative news. In many ways, we tend to create opinions or judgements based on our first impressions which becomes difficult to change later.

3. Narrative fallacy: 

We often fall for stories and narratives and often forget to see if they are supported by proper evidence. In the world of social media, these narratives often shape our opinions on everything, including our investments. Unsolicited ideas and money-making strategies are readily available at the click of a button. In such an age of information, we need to be careful in building and shaping our knowledge based on facts and evidence and not on unverified narratives.

4. Hindsight bias: 

The tendency to believe that we could have predicted an event after it has already happened. For example, an investor may exit a market after it has fallen, believing that they should have sold it sooner. Often, we tend to believe that our knowledge and judgement are good after an event has happened even though this may have been for any other reason. Unknowingly, we would become biased on the hindsight of an event happening.

5. Planning fallacy: 

We often do a lot of planning for things like buying a mobile or going on a long vacation. However, when it comes to investments, we tend to underestimate the amount of time and resources it will take to do it ourselves. With easy information available, we tend to jump to conclusions very fast and think investing is simple and easy. Unfortunately, it takes time and a few losses to acknowledge our mistakes. Investing needs proper planning, knowledge and expertise and lots of behavioural traits over time to be successful.

6. Loss aversion: 

Our bodies and minds have evolved to avoid pain, even the slightest ones. Thus, we tend to feel the pain of losing money more acutely than the pleasure of making money. This can lead investors to make irrational decisions, such as holding onto losing investments too long or selling winning investments too soon. Loss aversion is very common amongst investors and something to look out for to avoid making wrong decisions.

7. Herd instinct: 

Again, our minds have evolved to see safety in numbers. We tend to follow the crowd, even when it is not in our best interest. We feel that the majority is unlikely to be wrong and even if everyone is wrong, I will not be alone. We see this repeating often in how the market behaves during different boom and bust cycles and the surprising number of new investors falling for this mentality.

8. Confirmation bias: 

It is human nature to have the urge to be right and find ways to prove the same. We unknowingly seek out and interpret information in a way that confirms our existing beliefs. We risk ignoring and giving less importance to facts that counter our beliefs and tend to find comfort in what we already know. As investors, we should be open to ideas even if they are against our beliefs, challenge our understanding and accept that our notions and beliefs can be wrong.

9. Overconfidence bias: 

Often, new investors after initial success believe that their knowledge is adequate and they are smart enough to play the game. The tendency to overestimate our own knowledge and abilities is the overconfidence bias we have. A parallel can be drawn in the case of driving too, where almost 90% of people would believe that they are better than average drivers. With this bias, there is a risk that we make decisions prematurely or without adequate research trusting more in our own abilities. 

10. Familiarity bias: We tend to find comfort with what we know and there is a tendency to prefer things that are familiar to us. We tend to avoid unfamiliar or unchartered avenues. We can see this with the older generation who are generally risk-averse and prefer to invest in traditional avenues. With this bias, we may risk neglecting and not learning enough of the opportunities out there and staying stuck with sub-optimal choices in investing. 

How to mitigate the impact of personal biases on your investments:

Now that we know about the biases we can have in investing, the question is what to do next? Well, there are a number of things that investors can do to mitigate the impact of personal biases on their investments. The first and foremost is to educate ourselves about personal biases. The more we know about personal biases, the better equipped we will be to identify and mitigate their impact on our investment decisions. Being open, flexible and with a bit of introspection, we can overcome a lot of biases. 

Next is to create an investment plan and stick to it. An investment plan can help you to avoid making impulsive decisions based on your emotions or biases. As investors, we should focus on learning and keeping an open mind to ideas for a long journey towards financial well-being in life. We should be smart enough to avoid noise and filter information after judging and validating information from diverse sources. Lastly, it is recommended that we also get professional or expert advice. They can extend a holding hand in managing our emotions and our biases in our investment decisions. By understanding and mitigating the impact of personal biases, investors can make more informed and rational investment decisions.

Friday, Nov 24 2023
Source/Contribution by : NJ Publications

Financial behaviour and financial decision-making are two closely related aspects of an individual’s financial well-being. The impact of financial behaviour on the financial well-being of an individual has long been a subject of interest for researchers. 

Before we proceed, let us first try to understand these terms which we use in our daily lives 

Financial Behaviour: 

Financial behaviour is how individuals respond to the information obtained and take action in the form of decision-making. It refers to the way a person makes financial decisions, manages his money and deals with financial issues. This can be influenced by a number of factors like education, personal experiences, culture, personality, upbringing, income level, present financial situation and the influence of others on financial matters. 

Financial Well-Being:

The way people feel about their financial situation can be considered as financial well-being. It is a state of being wherein a person can meet current and ongoing financial obligations, feel confident and secure in their financial future and be able to make choices that allow them to enjoy life. 

Understanding the relationship:

As said, financial behaviour impacts the financial well-being of individuals. Studies have shown that individuals who engage in healthy financial behaviours, such as budgeting, saving, and investing, are more likely to achieve their financial goals and build financial security over time. Conversely, individuals who engage in unhealthy financial behaviours, such as overspending, impulse buying, and excessive debt, are more likely to experience financial difficulties and stress.

Here are some specific ways in which financial behaviour impacts financial well-being:

Budgeting: 

Studies have found budgeting is an essential tool to create financial stability and discipline. People who kept budgets were able to track their income and expenses, make informed financial decisions, and stay on track to honour their commitments and better achieve their financial goals. A recent study by the RBI found that only 31% of Indians have a budget. This suggests that there is a significant opportunity for financial education and awareness to improve financial budgeting behaviour in India.

Saving: 

Saving is something found to provide psychological security and help boost your overall sense of well-being. Surely, saving is a very essential component of financial well-being and allows individuals to build a financial cushion to cover unexpected expenses as well as save for long-term financial goals. It simply involves setting aside a portion of income regularly. Saving money is a discipline that requires individuals to be committed and consistent. While, in general, there is a healthy savings culture in India, savings is something which can easily be influenced more by culture, personality and values. 

Investing: 

Investing is a way for individuals to grow their wealth over time by investing in assets that deliver higher net returns above inflation. Investment behaviour and decision-making have a sizable impact on financial well-being. The investment choices we make, especially the asset classes and the investment products go a long way in determining how much wealth we build. An individual’s personal experiences, knowledge and interest in investments go a long way in shaping his/her investment behaviour. For eg., investors are often found to systematically hold on to losing investments far too long than rational expectations would predict, and they also sell winners too early. 

Spending: 

Spending is linked closely to your financial well-being. Studies show that poor control over spending is linked to materialism and status-seeking along with impulsivity and low self-control. Basically, one can also break this up into compulsive and impulsive spending. While impulse buying is largely unplanned and happens at the moment in reaction to an external trigger, compulsive shopping is more inwardly motivated. There are also instances where people were found to be addicted to spending. Overspending was found to lead to debt problems and financial stress. 

Debt: 

Debt is often closely linked to financial stress, stability and freedom of individuals. The credit behaviour in Indian society has undergone radical change both from the perspective of acceptance and access. With easy access, however, the debt burden on individuals has gone up significantly. Individuals who are mindful of taking credit and repaying the same on time can be expected to be closer to financial well-being than those who rely on debt as a part of life. 

How to improve your financial behaviour:

If you are interested in improving your financial behaviour, there are a few things you can do:

1. Learn Personal finance  

The more you know about personal finance, the better equipped you will be to make sound financial decisions. There are many resources available to help you learn about personal finance, such as books, articles, and online courses.

2. Set Financial Goals

What do you want to achieve with your money? Do you want to buy a house? Save for retirement? Start your own business? Once you know what your financial goals are, you can start to develop a plan to achieve them.

3. Automate Savings and Investments 

One of the best ways to ensure that you are saving and investing regularly is to automate your savings and investments. This means setting up a recurring transfer or say SIP in a mutual fund portfolio from your bank account to your investment account each month.

4. Get Professional help 

If you need help with your personal finances, there are a number of professionals who can help you, namely Registered Investment Advisors and mutual fund distributors. 

Conclusion:

Your financial behaviour has a significant impact on your financial well-being. By developing healthy financial behaviour, one can improve the financial situation dramatically. As one learns, introspects and improves one’s actions and behaviour, progress happens. What is needed is the right attitude to acknowledge and evaluate the problems and the possibilities out there. Even if we simply practice what has been mentioned in this article, that should be enough for us to get ourselves on track to financial well-being.

Friday, Oct 27 2023
Source/Contribution by : NJ Publications

In the world of investing, the pursuit of wealth comes hand in hand with the need for effective risk management. As investors navigate the complex wealth management world, they must realize that wealth preservation is as crucial as wealth accumulation. Every investment faces some risks that can potentially lead to financial losses or lower-than-expected returns on investments. Whether you choose to invest or not invest, you knowingly or unknowingly are taking risks. Identifying and understanding these risks becomes important for any investor so that one can effectively either avoid or reduce or take measures to manage the risks. 

There are several key types of investment risks that investors should be aware of and this article aims to shed light on the types of investment risks faced by investors and the brief ways of managing these risks prudently.

1. Market Risk: This is the risk emanating from overall market conditions and economic factors which can lead to the decline of investment value. We can extend this to risks related to changes in government policies, political instability, and regulatory shifts affecting investments. One can easily manage this risk with diversification at the asset class level and by having some understanding of the long-term market prospects given the conditions prevalent today.     

2. Interest Rate Risk: The risk associated with changes in interest rates affecting the value of fixed-income or debt investments, like bonds. As interest rates rise, the value of debt investments fall and vice-versa depending on the maturity period of holdings. One can choose to diversify across different maturity levels and issuers to reduce this risk. Understanding interest rate cycles can also help us to manage this risk appropriately. 

3. Credit Risk: The risk that issuers or borrowers may default on interest payments or principal repayment, particularly relevant for bonds and loans. One can diversify across different issuers and credit ratings and choose to invest in highly rated instruments to reduce this risk. 

4. Liquidity Risk: The risk that investments may not be easily tradable at desirable prices, especially with less liquid assets. One can diversify into liquid assets and maintain an emergency fund for unexpected expenses to avoid selling illiquid assets in a hurry.

5. Inflation Risk: The risk that the purchasing power of investments may erode due to rising inflation. The best way to manage this risk is by investing in asset classes that give positive real, post-tax returns net of inflation. If you are only a debt investor, you can explore diversifying into other asset classes, especially equities, that have the potential for better real returns in the long term.  

6. Specific /Unsystematic Risks: Risks associated with investing in a certain companies, sectors, or specific groups of companies including management issues, competition, supply chain disruptions, technology disruptions, etc. Such risks can be easily managed with diversification to reduce the impact of adverse events in a single company or group of companies.

7. Event Risk: Event risk relates to unexpected events that can impact investments, such as natural disasters, wars, or epidemics at the macro level or to personal life, health, and property at the micro level. In recent years, we have seen such risks globally and limited to specific countries. Again, the best way is to diversify, stay informed, and to also consider insuring yourself against any risks faced at the personal level. 

8. Longevity Risk: This risk is associated with the uncertainty of how long you will live and whether your investments will last throughout your lifetime, especially when planning for retirement. The best way to manage this risk is to ensure that while planning, you factor in this risk and create assets that will continue to grow and/or bring you lifelong cashflows. Also, ensure that you are appropriately covered by health insurance with high coverage.    

9. Behavioral Risk: Behavioral risk involves emotional factors influencing investment decisions. Quite often, we may make financial decisions based on biases and emotions. What we do becomes very critical over the long term and is something that will disproportionately impact our wealth in the long term, even when we do not realise this. 

How to avoid and manage the risks: 

1. Diversification: The idea is to diversify and spread investments to reduce the impact of market and specific risks or risks of concentration limited to specific asset classes, companies, market capitalisation, sectors, etc. A proper diversified asset allocation is the starting point and then diversification with-in the asset class can help reduce the risk further. 

2. Research and Staying Informed:  

As investors, we should have some degree of information and updates on the economic scenario and the prospects for equity and debt markets. Having a broad understanding and expected medium to long-term trends can help us manage our asset allocation and market risks, systematic risks, and interest rate risks better.  

3. Long-Term Perspective: 

Evidence suggests that the market volatility or fluctuations tend to even out in the long run so by staying invested for the long term we tend to see more predictable and positive returns. This is why we say that for equities, we ideally have to only invest for the long term. A lot of systematic risks and market risks get settled /reduced in the long run. 

4. Expert Guidance: 

Guidance and hand-holding by an expert goes a long way in managing risks is a much better way. The cost of learning, gaining experience, and opportunity costs for the initial years can be much higher and set you back by many years. Further, with expert guidance, we surely can expect one to avoid emotional and behavioural mistakes and help shape our investment approach, something which can greatly impact your long-term financial well-being.   

Conclusion:

In the dynamic investment landscape of India, effective risk management is not a choice; it's a necessity. Diversifying your portfolio, getting adequate insurance, and handling investment behaviour are all vital components of a holistic risk management approach. With the guidance of seasoned experts and professionals like mutual fund distributors, you can have custom plans and a suitable investment portfolio to navigate the Indian market confidently as per your needs and risk profile. Happy investing!