Behavioural Investing

Human mind seeks constant activity while investing requires consistency and patience.

“Investing should be more like watching paint dry or grass grow”

– Paul Samuelson Economic Nobel Laureate

Primarily, investment decisions should be centered around:

• pursuing safety of capital than chasing the fads/ acting on hot tips
• ensuring cost optimisation than falling for complex and hard-to-understand products
• sticking to one’s asset allocation than getting swayed by glamorous sales pitches
• participating and staying invested than flipping/ making constant changes

Even though ‘compounding’ has been proclaimed as the ‘eighth wonder of the world’, by none other than Albert Einstein himself, it is seldom practiced by investors while managing their portfolios. In his book ‘The Psychology of Money’, the author Morgan Housel states that “progress happens too slowly for people to notice, but setbacks happen too quickly to ignore.” Murphy’s third law states that “everything takes longer than you think it will.” This partly explains as to why ‘long term thinking’ is so hard. And at the same time the truth is that compounding – a by-product of long term orientation – is a magical force, quietly working as a growth agent on one’s investments. In fact Morgan Housel further elaborates on this aspect that “Growth is driven by compounding, which always takes time. Destruction is driven by single points of failure, which can happen in seconds, and loss of confidence, which can happen in an instant.”

One of the reasons why investors find it difficult to maintain a ‘long term orientation’ on their investments is that, over a period of time, most investors will go through a cycle of greed and fear. While greed or over exuberance can compel an investor into taking rash decisions, excessive fear or a feeling of gloom can freeze the investor. These are extreme situations and require logical and rational thinking before taking any decision with regards one’s investments.

The other factor, impacting decision-making is the ability to handle ‘volatility’ which is also referred as risk. Willingness to take risk has more to do with the individual’s psychology than with their financial circumstances. Some clients will find the prospect of volatility in their investments and the chance of losses distressing to think about. Others will be more relaxed about those issues. Whether the actual risk is taken or not is also affected by both the resources that a person has (more the available resources more are the chances that the risk will be taken) and the need to take the risk (more important the payoff is for the person higher are the chances that the risk will actually be taken).

While the investing landscape is ever-changing and is constantly evolving, the investor must continue on the journey that has been planned in advance, while managing the emotional upsurge caused by the market cycles. An economic/ financial crisis might lead investors to prefer safe assets but that could actually be the right time to invest (more) as the prices are low. On a different occasion, the asset prices may continue to rise, in the absence of fundamentals (such as Earnings) and that may be an opportune time to take a re-look at one’s asset allocation.

To be able to improve the quality of decision making, an investor must learn to keep his/ her emotions under the able check of one’s intellect (the human faculty to think and reason). The moment you are able to take a step back, in the midst of a highly emotive situation, and look at the situation through the prism of logic and reasoning, you will probably make the best possible decision for your portfolio. While what is being suggested isn’t easy and may not come naturally to you, but with constant practice and by being mindful of the virtues of placing intellect over emotions, you can surely master the technique of making right decisions with regards one’s investments. Of course, the presence of a well-meaning professional around you could be a value-add to your decision-making process.