4 behavioural biases that negatively impact one’s ability to invest in and how to avoid them

Today it feels like everyone is a Jhunjhunwala, but if that were the case, all the investors would be living in million dollar mansions with ocean views. It is important in these times to keep a level head and a cool attitude and avoid the many biases that leave us nursing our wounds when the bears come out to play.

As the Bhagavad Gita succinctly reminds us, “To him who has mastered the mind, the mind is the best of friends; but to him who has failed to do so, his own mind will be his greatest enemy.”

Let us then decide to be friends with our mind by overcoming our biases when it comes invest. Some of our most notable ones are:

Herd bias combined with plain terrain bias: Collecting flavors of the month along with everyone else – from the FAANGS to the HRITHIKS, to AI stocks or Encrypted it can leave a person in a dangerous situation and at risk of attack. While they can be great companies or opportunities with a strong history of building wealth, they may not always be available at great valuations.

Just because a certain investment has done well for a period of time, does that mean it will continue to do so? There are always constant disruptions, business cycles or valuations that require the idiot theory to play out more. Apple may be a great company, but do everyone’s pensions depend on it growing at the same rate forever?

We must independently and continuously review our positions and themes to ensure that we are not complacent with the tendencies of the past year.

Stereotyping with vicarious bias: A dangerous combo – I often hear my mother giving me advice on what to invest in based on her stock picks from her relatives. The old saying “always listen to your mother” probably doesn’t apply here.

First of all, she did not do any work for the company, the sector or even the valuation and secondly, it’s probably “exciting” in a space she’s interested in.” After all, everyone uses the internet or needs toothpaste.

But let’s face it people, this investment technique doesn’t scream success. However, investing is something people hear by hearsay all the time without doing any real research.

The market will test your conviction, by showing you a violent red, or simply keep the stock stagnant for long periods of time until the investor gets tired and you throw in the towel. stay submerged for years until the story plays out. “Borrowed conviction” and “cursory knowledge” will only get you so far, but first one must be able to understand the company and secondly, be willing to go into the trenches to ensure that the guns blazing.

Overconfidence bias: When the markets are going strong, we can all be guilty of being overconfident and thinking we now have George Soros. We are reluctant to take money off the table and everything we invest in, we think, will be multi-bags. This is clearly not the case. And contrarian nature is needed, even on the way up.

Loss aversion bias: On the flip side, there are people who avoid investing in stocks altogether. Humans, by nature, find it difficult to avoid risk because the pain of downside is more significant than the pain of upside. It generally stems from the time when our ancestors, when we heard rustling in the bushes, were faced with the choice of “fight or flight”. dinner of the saber-toothed tiger.

Therefore, hundreds of years later, there are some people who rather play it safe and keep their extra funds in the bank, bonds and other safe but low-yield products. But it’s clear that when we look at time, equities outperform most other asset classes as long as one is willing to accept and absorb volatility, which is nothing but loss opinion Although at the time when you see all red, it feels quite painful. But to avoid proper asset allocation, they are more likely to sit in the shallows all the time without letting their money work for them.

These are hard to beat inclined, but it is advisable to keep a moderate attitude and avoid being greedy by taking money off the table in a measured way and thus de-risking one’s portfolio. One should be willing to put in the groundwork to understand a company’s intrinsic value because that will be your anchor when the tide turns.

Arun Chulani, Co-Founder, First Water Capital Fund.

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Updated: 16 November 2023, 03:01 IST