Behavioural Finance – Are investors thinking, feeling or merely behaving?

Our behavioural biases impact our thinking and decision-making skills a lot more than we are aware of. It astonishes that something as abstract and cardinal as that has the ability to cost us hundreds of thousands of rupees.

Behavioural Finance suggests that psychological influences and biases impact the financial behaviours of investors. It suggests that investors are not always rational and that even they have limits to their self-control. A behavioural bias is forming opinions from out of our life experiences; based on limited information and lack of objectivity.

Therefore, what are the things we can do to avoid falling prey to and acting on such biases? The first step is acknowledging that such biases subtly exist and becoming aware of their sway.

Let us see some of the behavioural investing mistakes that are costing us money.

Recency Bias

People tend to recall more vividly incidents and experiences that have taken place recently, compared to older experiences, and end up giving them a higher weightage due to the time factor.

Many a times, if the market has been down in recent times, investors opt to stay away from it, not realising that both ups and downs are part of the game and graph. Alternately, if the market is on the positive area of its graph and soaring, investors sometimes take comfort solely in this fact before placing huge sums of money in the market.

Selective Bias

Sometimes, through social interactions or other sources, we are almost convinced about our buy/sell/hold decision but due to having large amounts at stake, we feel like cross-checking the facts just to be certain. Yet, while doing research, we are so slow and reluctant to change our beliefs to match new evidence that we stick to the facts that back us up and choose to ignore the ones that do not. Accordingly, we may not always arrive at the decision that is best in the changed circumstances.

Regret Avoidance

It pains us to see loss of money as the stock value dips and seems to be continuing to do so. It is even worse when it was a risky decision with the potential for high rewards. No one likes to admit having made the wrong call, and we feel better sitting with the thought that the losses are unrealised, and with the slight hope that the stock will come back up at some point. However, rationality and logic advise to abandon a sinking ship rather than go down with it.

Awareness of such commonalities improves performance and knowing the signs can aid us in reducing or avoiding such investment mistakes.