Don’t Be Your Own Enemy
Three key behavioural traps that investors need to guard against in the current scenario
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Today, a conflux of global and local factors has resulted in a situation where Indian investors are particularly susceptible to falling prey to their own behavioural pitfalls. After a rip-roaring 2017, equity markets have entered an extended time-correction mode ahead of the 2019 general elections. The all-important earnings growth rate, though showing promise, is yet to find its sea legs. Debt mutual funds, hailed as the FD investor’s saviour not long ago, have mostly disappointed over the last year and a half. The purported real estate ‘turnaround’ story remains subject to speculation, as the sector appears to be putting together only a lacklustre recovery at best. An enigmatic motley crew of cryptocurrencies zoomed ahead in 2017 leading to a hectic proliferation of Bitcoin wallets, only to crash more than 60 percent from their yearend highs. Aiming to keep your head above water amidst this bedlam? Here are the top three behavioural investing traps that you need to insulate yourself from right now.
The siren song of stories
Of all the behavioural traps that investors succumb to, few stand out like the innate tendency to fall prey to stories. The seductive allurement of stories, it would appear, is hardcoded into our DNA. In the investing world, the power of stories can prove especially dangerous, and can even serve to trigger a host of other dormant behavioural biases. Basically, stories regularly influence investment decisions; and usually not in a good way.
IPOs are a prime example of the power of storytelling. Did you know what your absolute returns would be today, 8 years later, if you had invested equal amounts of money into every single IPO in 2010? The answer is: minus 8 percent. More often than not, IPOs make terrible investments; and yet — investors continue to frenetically jostle for a piece of the pie! The better the story, the higher the oversubscription. Stories trump evidence and facts each time.
Stories (or the lack of them, in this case) also serve to keep investors away from beaten down stocks during their most lucrative windows of opportunity. After all, the most admired companies tend to be the ones that have done really well — financially and stock-pricewise — in the recent past. They also often tend to be overvalued. You’d do well to watch out for this all too common bias!
The Conservatism Bias
There’s a reason why ‘keeping an open mind’ is one of the ten investment maxims proffered by none other than investing maestro Sir John Templeton. But in order to keep our minds open, we need to overcome the tendency to cling steadfastly to a prior viewpoint; even in the face of new information. In other words, we often become ‘perma-bulls’ when it came a particular asset class, and ‘perma-bears’ when it comes to another. Facts change; but we don’t change our opinions. Put simply, we tend to severely under-react to facts that should ideally make us change our minds.
Broadly speaking, there are three ways in which this bias could be manifesting in your investing life right now: You could be a perma-bull for equities, and therefore be turning a blind eye to the fact that the NIFTY’s still trading at 28 times current earnings; and thus, be stubbornly refusing to de-risk and rebalance your portfolio. Two, you could be a perma-bull for real estate, and therefore be ignoring the fact that the sector is still grappling with unsold stock and sticky prices. And so, you continue to pay your interest-laden EMI’s and hang on to your real estate for dear life, at great cost. Three, you may have burned your fingers in debt funds of late and are refusing to note that a lot of the “nasty stuff” is already priced into current yields; and the next couple of years actually look pretty good.
What’s common between Goalkeepers and Investors? It seems that both tend to have a proclivity for action – and not always to their benefit, mind you. This behavioural bias, known as the ‘Action Bias’, has trounced many an investor over the years.
In other words, we love quick results just as much as we love instant noodles! We also loathe ‘doing nothing’ with our investments. It wouldn’t be unfair to say that today’s mercurial investor suffers from an affliction called ‘Investment ADHD’ (Attention Deficit Hyperactivity Disorder); studies have shown that the global average holding period for stocks has been falling consistently over the years.
There’s a double whammy effect in play when it comes to the Action Bias, as investment losses actually serve to augment this tendency. In other words, you’re a lot more prone to ‘acting’ when the chips are down – doing fruitless things like selling off underperformers after they have underperformed, potentially at a recovery-cusp. Talk about a snowball effect of underperformance leading to more underperformance!
A classic case in point is what’s happening with Equity Mutual Fund SIP’s (Systematic Investment Plans) right now. SIP’s that were started post-demonetization haven’t exactly delighted investors – many of them are still in the red a year or more later. Anecdotal evidence suggests that the malaise is already starting to build within SIP investors; particularly those who got in with a poor understanding of the non-linear nature of their returns. Will stopping your SIP’s and re-starting later help? Most likely not, since SIP’s are long term investments that actually rely upon the skittish nature of the equity markets to generate superior risk-adjusted returns over longer timeframes. If you find yourself succumbing to this bias right now, take a pause and remind yourself that you didn’t start your SIP’s to speculate, but to create long term wealth. Better yet, align your SIP’s to long term goals such as your retirement or your child’s education; there are few things as effective as a tangible, relevant and distant prize to keep you on the ‘straight and narrow’ path on your investment journey!