November 18, 2013

Ostrich Effect and your investment decisions

What you will do if the mutual fund which you invested is continuously under performing to its peers for years? Few switch over to another fund but the majority will continue in the hope that it will perform well in the future. This tendency of human to not heed the bad news about their finance is called “Ostrich Effect” in behavioral finance.

Ostrich

Why this name called “Ostrich Effect”? When Ostrich feels scared then it buries its head in the sand 🙂 Maybe in a illusion that bad news never exists or neglecting the bad news. Seems funny to all of us. But in reality we too follow the same way when it comes to bad news about financial problems or bad news related to our investment.So reacting to bad news is good or bad? Yes it is good in a few cases and bad in others. So let us see in detail.

So reacting to bad news is good or bad? Yes it is good in a few cases and bad in others. So let us see in detail.

Advantages of this effect

When you are investing with long-term perspective then I don’t think day to day bad news about economy or company matters more unless there are any major changes in fundamental views. So ignoring such news is actually a good sign of long-term investor. By ignoring such news investors continuously invest irrespective of market condition. This actually leads to a systematic investment style and effect to good sign of financial life.

Also psychological impact of such news is minimal when you ignore any bad news of market or simply to say follow the Ostrich Effect.

Disadvantages of this effect

Sometimes it happens so that ignoring the bad news may lead to major loss in investment. Because in few cases you find that there is no hope of recovery from such investment as bad news continuously persist.  So coming out of such investment is wiser idea than ignoring the bad news.

If you miss the bad news effect on market then there is highly probability that you may miss the investing opportunity. So it is always not a good idea to follow the Ostrich Effect.

Some of the examples wherein we never need to ignore the negative or bad news about our finance are ignoring the steep credit card statement or not having a proper spending habit.

Hence this Ostrich Effect have both advantages and disadvantages to investors. So following the approach like when to ignore and when to heed will be a prudent idea.

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