Musings
You vs You - How to overcome emotions while investing
Have you ever thought if you would act against your own interest? That too consciously? Most people, when asked the question, respond with a thumping “NO”. When this question is framed differently, their response varies. For instance, when asked, “How many times did you indulge in junk food in the last 30 days, knowing that it is unhealthy?” or “How many times in the last month did you switch off the alarm meant to wake you up for your morning jog and continued sleeping?” There are several examples of us acting against our own interest. Many smoke, eat the wrong food, drink excessively, spend recklessly, do not focus on building careers, etc.
The same is true for investments. Certain people do act against their own interest. The reason for this deviation from the right path, in life as well as investments, is that it is not exciting enough to stay focused on the goal for a long time. So many health experts state that a little yet regular exercise routine goes a long way in staying fit. Yet we find it difficult to stay disciplined. Investments is no different. During tough time, certain people behave in illogical ways since staying rational seems difficult. And so, herein we focus on common investment mistakes (technically referred to as ‘biases’) people make and we will attempt to provide some simple solutions to avoid making investment related mistakes.
Loss aversion bias
For some reason, the pain from losses is felt more severely than joy of a similar gain. Let us look into an example.
Which scenario will make you happier?
Most of us choose the first scenario, though the payoff from both the scenarios is exactly the same, an addition of Rs. 500/-. Why does this happen?
Let us take another example related to investments.
Which scenario makes you happier? Again, the payoff is exactly the same, a gain of Rs. 600/- in both scenarios. The second scenario is likely to result in disappointment as there is feeling of “What if I had sold at Rs. 2,000/-?”. Some people even term it as a loss of Rs. 400/-. Loss aversion makes us fearful when investing in equities, resulting in irrational behavior. Many investors totally avoid equities for this reason and solely prefer safety, though equities can reward investors in the long term.
How to deal with Loss Aversion Bias: Do not invest in volatile asset classes like stocks directly. Instead, choose a mutual fund (MF). MF being a diversified instrument, your losses may be lower than a one stock portfolio in a downturn situation. Taking the help of an advisor can also help to deal with emotions while investing since the advisor will guide you appropriately and give you the larger picture during tough market conditions.
Herd mentality
The world of fashion successfully thrives on this trait. Any new fashion trend if endorsed by a few celebrities influence the masses to adopt. Similarly, in the field of personal finance, herd mentality refers to the behavior of investors who tend to “go with the trend” while taking decisions.
Many are influenced by what others, like friends, relatives or neighbours are doing. In the age of internet and social media, the impact of such behavioral trends can be high, and need not be restricted to the circle of friends or neighbours. In the stock markets, we have repeatedly seen herd behavior, be it the euphoria surrounding the technology stocks in 2000 or the power and capital goods stocks in 200 or the emergence of Covid-19 pandemic. A common feature of these trends is that of a strong run up in these stocks in the immediately preceding time period leading to a feeling of fear of missing out (commonly referred as “FOMO”) among many. For instance, currently we are seeing a rise in interest for directly trading in stocks among new investors as indicated by the jump in new demat accounts in the last two years. While a host of user-friendly apps have facilitated this phenomenon. New age investors need to appreciate that it is difficult to consistently replicate recent returns, especially on their own. Further, investing is a full-time profession requiring knowledge, experience, discipline, teamwork and an institutional framework that brings along a process driven approach and risk management. In other words, investing in a mutual fund is a better option for an individual investor as compared to direct stock buying.
How to overcome herd mentality: The answer lies in asset allocation. While asset allocation and the practice of jotting down your goal in money terms are essential tools for portfolio diversification (ensuring all eggs are not in the same basket), it also helps in fighting temptations to chase momentum in a particular asset class. Investors can also gradually book profits when they are approaching their goal.
Availability bias
It is a human tendency to get influenced by events that come readily to our mind, while taking decisions. More often than not, most recalled events are unpleasant ones related to temporary loss of capital. When we mention ‘risks in equities’, the things that immediately occur to most people would be the sharp correction during the emergence of Covid-19 pandemic, global financial crisis or the dot com bubble. Similarly, “Black Mondays” and “Tragic Tuesdays” are often remembered. As a result, these events become more representative than they need to be while making financial decisions. Many investors are under-invested in equities in their overall asset allocation due to fears instilled on account of availability bias. Would you not agree that the news most remembered is not always the pleasant one but a controversial one? Same is the case in investments. People generally remember bad days over good ones.
How to deal with availability bias: A simple SIP could do the trick. An investor who invested through the ups and downs of, say, Covid-19 pandemic and subsequent recovery would have done well over a period without displaying extreme emotions.
Mental accounting
We all keep mental accounts by allocating a particular sum of money for a particular purpose. In our minds, we compartmentalize our earnings to be spent towards rent, entertainment, travel, retirement corpus, etc. Most disciplined people make little changes to that. Some money is considered serious hard-earned money and some is the so-called luxury or fun money. For instance, would you spend your PF corpus on your next holiday? Unlikely, as there is guilt associated with spending PF Funds which are earmarked for an important life goal. There are many examples of mental accounting. However, mental accounting is also responsible for some negative outcomes. People tend to spend impulsively on a shopping trip using credit cards than parting with cash. Plastic money does not cause pain while spending. A few more examples of irrational behavior are as follows: tendency to spend tax refunds quickly as it is treated as a “windfall gain”. Monthly salary being viewed as “hard earned money”, but year-end bonus is for impulsive spends. Money is money, you might argue, but then, why this irrational behavior?
Use mental accounting to your advantage: It pays to attach a goal while investing, thereby inculcating discipline of staying invested for the long term and rationalize spending. There are goal oriented mutual fund scheme categories like Retirement Funds and Children’s Funds. Typically, it is advised to have one SIP per goal.
Short-term thinking:
As far as personal finance is concerned, short term thinking can impact us in two prominent ways. The first is that we get carried away while spending and do not save enough. In an age of instant gratification, even large ticket spending, like that on a TV, furniture or even a car, can be done with a smartphone, backed by a loan and easy EMIs. It’s easy to lose focus on long term financial goals. Secondly, when investing in equities, sharp market movements in the short term can make us myopic to the magic of compounding that can unfold in the long term. A quick rally is enough to tempt us, and a quick crash is enough to scare us, to exit our investments.
Dealing with short-term thinking: Discuss your long-term financial goals with your advisor and form a financial plan. Invest systematically through SIPs to keep you disciplined to stay the course in the journey.
To conclude
Whenever we take a decision in any facet of our life, we try to be as rational as possible to avoid mistakes. However, it is undeniable that emotions like greed and fear are involved when we make investment decisions. Both these emotions lead to investment mistakes affecting investor’s returns over the long term.
For instance, HDFC Flexi Cap Fund has delivered a return of 19.05% per annum as on 31st May, 2024 since its inception on 1st January 1995 however, the returns earned by investors who entered and exited the fund at different points of time would mostly be different. There is no successful formula for an optimum time for entry and exit. Many investors end up earning lower returns than the fund itself due to these timing mistakes. Luckily, for us, the solutions available to deal with our emotions while investing are surprisingly simple. These include following asset allocation strictly, choosing mutual funds over direct investing, embracing systematic investing and taking the help of an advisor, to keep emotions at bay when investing. Remember, “You Vs You” is a battle you want to avoid!
Happy investing.
Views expressed herein involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied herein. HDFC Mutual Fund/AMC is not indicating or guaranteeing returns on any investments. Readers should seek professional advice before taking any investment related decisions and alone shall be responsible.
SIP Performance - HDFC Flexi Cap Fund - Regular Plan - Growth Option
SIP since inception* of ₹ 10,000 invested systematically on the first business day of every month (total investment ₹35.30Lakh) in HDFC Flexi Cap Fund would have grown to ~ ₹ 18.55 crore by 31st May, 2024 (refer below table).
Performance of other funds managed by Roshi Jain, Fund Manager of HDFC Flexi Cap Fund(who manages total 3 schemes)
Notes common to all tables:
Past performance may or may not be sustained in future and is not a guarantee of any future returns. Returns greater than 1 year period are compounded annualised (CAGR).Load is not taken into consideration for computation of above performance(s). Different plans viz. Regular Plan and Direct Plan have different expense structures. The expenses of the Direct Plan under the scheme will be lower to the extent of the distribution expenses/commission charged in the Regular Plan. Returns as on May 31, 2024. The above returns are of Regular Plan- Growth Option.
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
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Have you ever thought if you would act against your own interest? That too consciously? Most people, when asked the question, respond with a thumping “NO”. When this question is framed differently, their response varies. For instance, when asked, “How many times did you indulge in junk food in the last 30 days, knowing that it is unhealthy?” or “How many times in the last month did you switch off the alarm meant to wake you up for your morning jog and continued sleeping?” There are several examples of us acting against our own interest. Many smoke, eat the wrong food, drink excessively, spend recklessly, do not focus on building careers, etc.
The same is true for investments. Certain people do act against their own interest. The reason for this deviation from the right path, in life as well as investments, is that it is not exciting enough to stay focused on the goal for a long time. So many health experts state that a little yet regular exercise routine goes a long way in staying fit. Yet we find it difficult to stay disciplined. Investments is no different. During tough time, certain people behave in illogical ways since staying rational seems difficult. And so, herein we focus on common investment mistakes (technically referred to as ‘biases’) people make and we will attempt to provide some simple solutions to avoid making investment related mistakes.
Loss aversion bias
For some reason, the pain from losses is felt more severely than joy of a similar gain. Let us look into an example.
Which scenario will make you happier?
Most of us choose the first scenario, though the payoff from both the scenarios is exactly the same, an addition of Rs. 500/-. Why does this happen?
Let us take another example related to investments.
Which scenario makes you happier? Again, the payoff is exactly the same, a gain of Rs. 600/- in both scenarios. The second scenario is likely to result in disappointment as there is feeling of “What if I had sold at Rs. 2,000/-?”. Some people even term it as a loss of Rs. 400/-. Loss aversion makes us fearful when investing in equities, resulting in irrational behavior. Many investors totally avoid equities for this reason and solely prefer safety, though equities can reward investors in the long term.
How to deal with Loss Aversion Bias: Do not invest in volatile asset classes like stocks directly. Instead, choose a mutual fund (MF). MF being a diversified instrument, your losses may be lower than a one stock portfolio in a downturn situation. Taking the help of an advisor can also help to deal with emotions while investing since the advisor will guide you appropriately and give you the larger picture during tough market conditions.
Herd mentality
The world of fashion successfully thrives on this trait. Any new fashion trend if endorsed by a few celebrities influence the masses to adopt. Similarly, in the field of personal finance, herd mentality refers to the behavior of investors who tend to “go with the trend” while taking decisions.
Many are influenced by what others, like friends, relatives or neighbours are doing. In the age of internet and social media, the impact of such behavioral trends can be high, and need not be restricted to the circle of friends or neighbours. In the stock markets, we have repeatedly seen herd behavior, be it the euphoria surrounding the technology stocks in 2000 or the power and capital goods stocks in 200 or the emergence of Covid-19 pandemic. A common feature of these trends is that of a strong run up in these stocks in the immediately preceding time period leading to a feeling of fear of missing out (commonly referred as “FOMO”) among many. For instance, currently we are seeing a rise in interest for directly trading in stocks among new investors as indicated by the jump in new demat accounts in the last two years. While a host of user-friendly apps have facilitated this phenomenon. New age investors need to appreciate that it is difficult to consistently replicate recent returns, especially on their own. Further, investing is a full-time profession requiring knowledge, experience, discipline, teamwork and an institutional framework that brings along a process driven approach and risk management. In other words, investing in a mutual fund is a better option for an individual investor as compared to direct stock buying.
How to overcome herd mentality: The answer lies in asset allocation. While asset allocation and the practice of jotting down your goal in money terms are essential tools for portfolio diversification (ensuring all eggs are not in the same basket), it also helps in fighting temptations to chase momentum in a particular asset class. Investors can also gradually book profits when they are approaching their goal.
Availability bias
It is a human tendency to get influenced by events that come readily to our mind, while taking decisions. More often than not, most recalled events are unpleasant ones related to temporary loss of capital. When we mention ‘risks in equities’, the things that immediately occur to most people would be the sharp correction during the emergence of Covid-19 pandemic, global financial crisis or the dot com bubble. Similarly, “Black Mondays” and “Tragic Tuesdays” are often remembered. As a result, these events become more representative than they need to be while making financial decisions. Many investors are under-invested in equities in their overall asset allocation due to fears instilled on account of availability bias. Would you not agree that the news most remembered is not always the pleasant one but a controversial one? Same is the case in investments. People generally remember bad days over good ones.
How to deal with availability bias: A simple SIP could do the trick. An investor who invested through the ups and downs of, say, Covid-19 pandemic and subsequent recovery would have done well over a period without displaying extreme emotions.
Mental accounting
We all keep mental accounts by allocating a particular sum of money for a particular purpose. In our minds, we compartmentalize our earnings to be spent towards rent, entertainment, travel, retirement corpus, etc. Most disciplined people make little changes to that. Some money is considered serious hard-earned money and some is the so-called luxury or fun money. For instance, would you spend your PF corpus on your next holiday? Unlikely, as there is guilt associated with spending PF Funds which are earmarked for an important life goal. There are many examples of mental accounting. However, mental accounting is also responsible for some negative outcomes. People tend to spend impulsively on a shopping trip using credit cards than parting with cash. Plastic money does not cause pain while spending. A few more examples of irrational behavior are as follows: tendency to spend tax refunds quickly as it is treated as a “windfall gain”. Monthly salary being viewed as “hard earned money”, but year-end bonus is for impulsive spends. Money is money, you might argue, but then, why this irrational behavior?
Use mental accounting to your advantage: It pays to attach a goal while investing, thereby inculcating discipline of staying invested for the long term and rationalize spending. There are goal oriented mutual fund scheme categories like Retirement Funds and Children’s Funds. Typically, it is advised to have one SIP per goal.
Short-term thinking:
As far as personal finance is concerned, short term thinking can impact us in two prominent ways. The first is that we get carried away while spending and do not save enough. In an age of instant gratification, even large ticket spending, like that on a TV, furniture or even a car, can be done with a smartphone, backed by a loan and easy EMIs. It’s easy to lose focus on long term financial goals. Secondly, when investing in equities, sharp market movements in the short term can make us myopic to the magic of compounding that can unfold in the long term. A quick rally is enough to tempt us, and a quick crash is enough to scare us, to exit our investments.
Dealing with short-term thinking: Discuss your long-term financial goals with your advisor and form a financial plan. Invest systematically through SIPs to keep you disciplined to stay the course in the journey.
To conclude
Whenever we take a decision in any facet of our life, we try to be as rational as possible to avoid mistakes. However, it is undeniable that emotions like greed and fear are involved when we make investment decisions. Both these emotions lead to investment mistakes affecting investor’s returns over the long term.
For instance, HDFC Flexi Cap Fund has delivered a return of 19.05% per annum as on 31st May, 2024 since its inception on 1st January 1995 however, the returns earned by investors who entered and exited the fund at different points of time would mostly be different. There is no successful formula for an optimum time for entry and exit. Many investors end up earning lower returns than the fund itself due to these timing mistakes. Luckily, for us, the solutions available to deal with our emotions while investing are surprisingly simple. These include following asset allocation strictly, choosing mutual funds over direct investing, embracing systematic investing and taking the help of an advisor, to keep emotions at bay when investing. Remember, “You Vs You” is a battle you want to avoid!
Happy investing.
Views expressed herein involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied herein. HDFC Mutual Fund/AMC is not indicating or guaranteeing returns on any investments. Readers should seek professional advice before taking any investment related decisions and alone shall be responsible.
SIP Performance - HDFC Flexi Cap Fund - Regular Plan - Growth Option
SIP since inception* of ₹ 10,000 invested systematically on the first business day of every month (total investment ₹35.30Lakh) in HDFC Flexi Cap Fund would have grown to ~ ₹ 18.55 crore by 31st May, 2024 (refer below table).
Performance of other funds managed by Roshi Jain, Fund Manager of HDFC Flexi Cap Fund(who manages total 3 schemes)
Notes common to all tables:
Past performance may or may not be sustained in future and is not a guarantee of any future returns. Returns greater than 1 year period are compounded annualised (CAGR).Load is not taken into consideration for computation of above performance(s). Different plans viz. Regular Plan and Direct Plan have different expense structures. The expenses of the Direct Plan under the scheme will be lower to the extent of the distribution expenses/commission charged in the Regular Plan. Returns as on May 31, 2024. The above returns are of Regular Plan- Growth Option.
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
