Reasons why individual investors loose money?
No doubt the ratio of the new investors joining different investment alternatives is growing. But while onboarding a new investor majorly the first concern an investor has is the safety of funds. Due to this very concern a lot of real life hustlers end up holding back.
So to clear this very insecurity this blog post will tell you what are the actual reasons if not paid appropriate attention may result in reduction in value of investment portfolio.
Behavioural Biases in Investment Decision Making
Both a fund manager or an investor needs to make decisions such as deciding which asset class to invest in, how to invest, timing of entry and exits along with reviewing & rebalancing of the portfolio. These same decisions are affected by behavioural biases of the decision maker, which leads to less than optimal choices being made.
Some of the well documented biases that are observed in decision making are:
1. Optimism or Confidence Bias
Often when an investor tends to believe that he now knows stuff that other people don’t, their comes a moment when he messes up. Because thinking that one is capable of outperforming the market every time now since it happened once is not the ideal thought process.
2. Familiarity Bias
We often hear that one saying that motivates some and usually annoys other people which is ‘Get out of your comfort zone’. Now an investor may be familiar with a stock or even a particular sector that he has greater information about. A clear example would be an investor holding only pharmaceutical stocks. Since opportunities are not exploited the portfolio is likely to be underperforming.
It’s all about the thought process and these very thoughts when stuck on some single piece of information may hinder profit making. Waiting for the right price to buy or sell and being stubborn thinking it is either my way or the high way makes the new information or data labelled as incorrect or irrelevant.
Example : Holding on to losing stocks in expectation of price regaining levels that are no longer viable given the current situation or data.
4. Loss Aversion
Everybody has experienced this at one time or the other. Initially every single one of us has to encounter a loss and that very possibility of happening it again can terrify. Studies show a pain of a loss is twice as strong as the pleasure one feels at a gain of similar magnitude.
5. Herd Mentality
This bias is due to a belief that others might have better information and that tendency of getting a confirmation before making a move forces ones mentality to often go with what other people are doing.
6. Recency Bias
Impact of recent events whether positive or negative can influence the decision making quite strongly. Like a bear market or a financial crisis makes people move to safer assets and bull market makes people allocate more funds to the riskier options of the portfolio.
7. Choice Paralysis
We all like options, in fact we love options as humans but the availability of too many alternatives to choose from makes our heart sink because most individuals are not good at making choices at time and this happens almost with every second person trying to be up to date with the market scenario by accessing the whole lot of information available out their leading to dilemma.
Professional fund managers have systems and processes in place to reduce or negate the effect of such bias.
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