Investment
Anchoring Bias
Overconfidence also leads to ‘ anchoring ’ bias where investors stay anchored to their initial forecasts and avoid changing them in response to new , especially contrary evidence .
Impact on investing
The impact of these biases can be myriad . However , the bottom line is that it can completely derail an investors ’ financial journey . “ Many biases happen because of information overload ,” believes Bala . She further adds , “ Biases lead to the inefficient choice of products that curtail the wealth building potential of an investor ’ s portfolio and encourages them to make suboptimal choices . People also often completely underestimate their future requirements and then are left grappling with insufficient funds post retirement ”.
Biases usually happen because of variations or volatility in investments . Active management of investment is usually not required . According to Jethwani , “ The idea is to optimise returns to your own behaviour .”
Investors should make investment decisions based on their goals and subsequent portfolio allocation . It is best to avoid chasing returns and to be weary of frothy markets . “ You don ’ t need large wealth to create wealth , you simply need focus and discipline with the money you earn and manage . If you manage to control these two aspects of your behaviour , then you need not control the outcome ; even investing `500 every month will help you generate a steady corpus over time ,” believes Jain .
How to reduce biases
Once investors are cognizant of the biases , they must make an effort to minimise the impact on their investment decision making . According to Bala , one of the best ways of handling human biases is to bring in automation in the
I am brilliant !
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Sandeep Jethwani Managing Partner and Head of Advisory at IIFL Investment Managers
‘ There is a tendency sometimes to get unduly influenced by our own investment experience ’
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Desperation investment process . “ Invest in products like systematic investment plans ( SIPs ) that automatically time the market by investing at all market levels ,” she says . Since the amount invested periodically is fixed , you tend to buy more when markets are down and less when the markets are trading at elevate levels .
Diversification is another tool that can helps investors deal with behavioural biases . Since volatility in investments is one of the main factors that contributes to an investor ’ s biases , diversification can help spread the volatility across different assets , thereby minimising its impact on investment decision making .
Investors should also rebalance
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their portfolios to the desired asset allocation on a periodic basis . Rebalancing ensures that investments that have performed well are sold so that they can be brought back to their original asset allocation , and investments that have lost values are bought for the same reason . “ This reduces the impact of behavioural biases by minimising risk , encouraging profit booking and ensuring that an investor buys lower priced assets ,” believes Bala .
From a wealth management perspective , the key is to understand that human behaviour cannot necessarily be changed . “ It is imperative that wealth managers clearly understand their client ’ s goals and objectives and walk them through various asset allocation scenarios highlighting historical returns and drawdowns . This can go a long way in helping investors understand how they would have reacted in extreme situations and accordingly structure their portfolios ,” believes Jethwani .
In investment decision-making , there are host of factors that influence and impact our ability to choose the right investments . Some we can control and the others we cannot . Behavioural biases can and should be evaluated to minimise their impact on our investment portfolio .
The author is a CFA - Strategic Consultant in financial markets
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Outlook Money July 2018 www . outlookmoney . com