10 common behavioural biases that impact investment decisions

Many investors do not take a disciplined approach to secure and grow their finances, due to certain biases. Such biases lead to mistakes like having inadequate or low life cover, avoiding or making low investments in equity-oriented investments, ignoring retirement planning and exposing to high-risk and unregulated investments.

This article flags those biases to help investors eliminate them for effective wealth creation.

Fear/loss aversion bias

A large section of people don’t dare to experiment, which is not any different in the case of investments. In India, this is a monstrous truth which is easily explained by the single-digit exposure to equity-oriented investments despite the fact they deliver the best of returns among asset classes over the long term. This fear originates from the conservative and traditional mindset of the inability to digest capital erosion in a bad market.

Here lineage also plays its part unless the person has the courage to break out of the conventional chain to experiment. The fear of being blamed by the family for losses in bad markets could also clip the interest to venture into equities. Sadly, only those who step out of this fear line can create better and significantly higher wealth than those stuck in the shell of fear.

Greed bias

Fast-money urge quite often ends up as fast poison when it comes to investments. Today many spoilers lure the fast money fans. F&O trading, online gaming and cryptocurrency which are kin of gambling that trigger greed have unfortunately amazed a great number of subscribers in recent years. These avenues lead to unaffordable losses and sadly at times cost lives due to the unbearable pressure and frustration.

The bitter truth about these avenues is that the very minuscule successes blindly motivate the addiction to keep trying and sadly most ultimately burn their fingers/money. The SEBI report of 9 out of 10 F&O traders losing money explains this vividly.

Influence by the experience of community/herd mentality

The experience of parents, friends, family and community both positive and negative influences investment decisions and even can form opinions about an asset class to embrace or avoid. This is so ridiculous as the experience of your acquaintance whom you get influenced by can be due to the market period when the investment was done or the choice of product. The result can be so different for you if you got these two factors right or wrong.

Also what is suitable for A may not suit B, as the risk profile can be entirely different. Risk profile is not about income or financial net worth or appetite to tolerate risk or understanding of various investment products or age and it is a combination of all, the sum of which is very often different from person to person. So, influence by acquaintances or herd mentality is insane when it comes to investments.

Familiarity bias

Familiarity with easily understandable products or products consumed/followed in daily life like fixed deposit, gold, chit funds and real estate forms an opinion in certain investors to believe only these are safe and better. So, they tend to keep away from products that require intense analysis and understanding like equity mutual funds and equities, despite their offering the best of returns.

This fact is reflected in the single-digit exposure of Indians to equities and equity mutual funds on the whole. This “frog in the well” mentality hinders the wealth creation potential as the above-mentioned familiar products hardly offer any real returns after the inflation effect.

Guarantee bias

Guarantee is a big hook for most investors and they get attracted to products that offer a return guarantee like fixed deposits, traditional insurance plans, government savings schemes etc. Investors miss out on realising that the guarantee comes at the cost of great return opportunity, and the guaranteed return products post inflation and post tax leave hardly anything on the table.

Market oriented investments like equity mutual funds and shares though cannot guarantee returns, over the long-term of more than 7 years comfortably yield low to mid-teen returns and with lesser taxation impact. The comfort of a guarantee creates great discomfort in the wealth creation process.

Recency bias

Recent memory and experience influence a large segment of investors and they tend to invest heavily in what has performed well recently. This can be seen now in a big way in mutual funds where investors have been investing heavily in sectoral and thematic funds like manufacturing, consumption and defence and smallcap & midcap funds which have done well in recent times and allocating less to largecap oriented funds.

The performers of recent times might have already lost their steam and at times it may be too late if just the recent history is considered, without analysing the future scope. One case from recent history that investors need to keep in mind is the kind of flow of money that real estate saw during 2014-2015 when real estate had been performing well for close to a decade.

But post this period of 2014-15, property prices hardly moved and were stuck for over 7 to 8 years till 2022 which is in fact a long period of negative returns, net of inflation. The case is even sad for those who had bought property on a loan.

Bias to solid/physical assets

There is also a common bias toward solid or physical assets like real estate and gold as the feeling of tangibility gives a sense of satisfaction of touch and feel, and people give more than warranted allocation to these assets. This is a misconception since investments are to be made to grow your money and not really to touch and feel.

Investments in equity, equity mutual funds, bonds and even digital investments in gold like gold ETF, gold funds and SGBs which are held in electronic form can be liquidated more easily than solid assets in case of emergency. In reality, it may be unsafe to hold gold in the physical form due to the risk of theft.

Influence of social media

The influence social media has on investment decisions is extremely high these days. A recent survey says 2 in 5 goals of millennials are influenced by Social Media. When social media can influence even the goals set by the current generation, it’s only understandable how much they would rely on social media to make investment decisions.

While SEBI has come out with strong guidelines for finfluencers, strict implementation of that is still far away. The sensitive and intensive topic of investment advice has been taken up by all and sundry on social media and investors who are so biased to blindly follow their suggestions, end up making wrong investment decisions by listening to them.

Past or initial experience bias

The first experience of investing in a particular product forms a sticky opinion in the minds of an investor and very often that experience influences decisions about investing in the future in the same product. This is more applicable in the case of investments where the returns are market-linked and not fixed. If the first time experience was great due to good market conditions, the motivation to invest more is high and if the first experience was bad they tend to avoid or resist the next time. However, this is not the right approach.

As long as the choice of an equity or equity mutual fund is right, if the investment is given a longer time it is most likely poised to deliver well. The mistakes of the first experience like the choice of investment suited to the risk profile and investment horizon can be corrected in the following attempts to improve and make good returns instead of getting opinionated by the first experience.

At the same time, a great first experience also doesn’t warrant a full and blind plunge as overconfidence can cost badly. The first experience of mis-sold ULIP investments done before 2010 by investors has left deep scars in their minds, which has created hatred towards the product for many. So much so that the word insurance itself has become an unpleasant one for a lot of people.

Bias based on financial security and inadequacy

One’s financial position also leads to a bias in investment decisions. Those who are financially strong may take two extreme paths of being aggressive in investment decisions to multiply, drawing confidence from their financial worth or being conservative or lazy to grow the money as they don’t feel the need. Few of such wealthy people may also take the middle path. There is a particular bias which is very often seen with wealth investors when it comes to term insurance.

Most wealthy investors tend to ignore term insurance as they tend to think their wealth can more than protect their dependents in their absence. They fail to realise the fact that a term insurance policy which comes at a low cost can keep their wealth intact and the insurance amount can provide the necessary financial protection to the dependents. Wealthy investors mostly fall under the aggressive risk profile and so can afford to make aggressive investments.

Similarly, financially weak investors also tend to take the 2 extreme steps of going aggressive to grow the money to create enough wealth or going very conservative as they cannot take the risk of losing the little they have. These investors may also take the middle path. Based on the investment horizon and risk profile these investors need to make investments with proper asset allocation.

Conclusion

Investors need to have long and in-depth engagements with investment experts, who can offer professional advice to clear them from their biases to make informed investment decisions. Regular review of portfolios along with an expert and the experience that can be drawn over time, makes one more mature to take unbiased investment decisions. Else, the biases can come as huge obstacles in one’s wealth creation journey.

V.Krishna Dassan, Director, Dhanavruksha Financial Services Pvt. Ltd.