Whether we are literate or illiterate, we have some mental blocks when it comes to investment. We simply follow those without knowing whether those beliefs are good or bad. Therefore, in this post I am trying to list a few of them.
1) Sunk Cost Fallacy–
Let us say you booked movie ticket for this weekend and suddenly on that particular bad day, you are not feeling well. So do you cancel the ticket or go to a movie? This booked ticket will not return you a single rupee in return if you cancel it. Few have the tendency to go to a movie as they paid it and not going is LOSS 🙂 Such tendency usually called Sunk Cost Fallacy. Let us have few more such examples, you bought a book on your friend’s recommendation or based on the good review. However, after reading a few pages, you found it to be dull or boring. Will you continue it to read only because you already paid for it? Let us say you went to movie and within 15 minutes of start you come to know what is the story all about, then will you continue to watch the movie until the end or come out of the theatre?
When we coincide above examples with our investments, then we have tendency to invest based on friends, relatives or expert advice. However, if that particular investment does not perform well and our portfolio showing negative returns, then we still continue in that investment and justify the investment. We do not think of come out of that mistake at the earliest. Instead, we feel that we already paid or invested in it. Therefore, we do not look back. Such type of tendency may also be called loss aversion as selling a loss making investment is twice painful than booking profit on investment.
It is always best idea to come out of investments which no longer adding value to your portfolio. However, at the same time do not look at recent performance to offload your investments. This again leads to below mentioned effect 🙂
2) Recency Effect–
Do you know how we forget few bad or good incidents, which happens to us? If any politicians do wrong, then we cry it like all went wrong and our country will be about to lose everything. However, such cry will be of short time. After a few days, we along with the media, which highlights such incidents, forget about it. Such short recency effect applies to our investment too.
When it comes to investment, we believe that what happened to recently will continue in future too. Therefore, if markets today are at all time high, and then it will be uptrend forever. Instead, we choose our investment products like mutual funds based on recent performance rather than giving more thrust to tag “Past performance is not an indicator of future performance”.
A typical real life experience is, when we toss a coin for around 100 times and found that 80 times we had the result of HEAD then we start to strongly believe that in next move we will get HEAD as a result. However, we simply forget that there is always 50:50 chance of getting HEAD every time we toss the coin.
Hence, while deciding your investments never ever rely on recent performance. Look at its consistency, and then go ahead.
3) Confirmation bias-
We humans have tended to be in the wrong belief that whatever we are doing is completely right. Therefore, to justify our actions or beliefs we search for information, which validates our decisions. In a recent study, researchers found that people spend 36% more time in reading information if it really supports their views or ideas.
The same applies to investment and that is the reason we find so many beliefs like equity is risky, gold and real estate’s are safest (but since few days gold investors were losing their faith :)), buying any products irrespective of financial outcome with LIC is good, because it is a trusted company or buying term insurance is totally a waste.
So the best way to come out from such belief is to always go for a second opinion. Through your EGO and go and meet some expert and take their opinion before jumping into well. However, finding an EXPERT is also a big task in financial jungle 🙂
4) Bandwagon Effect–
I know that I cannot afford the recently launched smart phone. Still follow my friend to buy it. Such mentality called as Bandwagon Effect or her mentality. We just follow the herd irrespective of its necessity or importance in our life. To make it simplified for you, during the 2014 election, we all voted thinking that Mr. Modi would definitely be our next PM as there was a huge MODI WAVE. This affected to few good politicians too, simply because they don’t belong to the BJP.
So never ever, follow the herd. Each individual has his unique financial life, goals, risk taking ability or strong beliefs about money. Hence, following such herd mentality will cost your financial life.
5) Negative bias–
We react more hardly than to neutral or positive news or results of our life. That is a reason one bad news (which not at all going to make investors money to sink totally) will have so much impact on stock market rather than neutral or good news. Hence, overreacting to negative than to positive is negative bias.
When your investment horizon is for the long-term, then I do not think short-term under performance, day-to-day media highlights, advisers’ negative reviews or dropping in star ranking will be of importance for you. Hence concentrate on long-term goals and always review the negative views with cautious than acting on them immediately.
I think we all have one or another above said mental blocks in our life about investment. Let us through them out and be smart investors 🙂
Image courtesy of [Stuart Miles] at FreeDigitalPhotos.net