Behavioural mistakes to avoid when investing

It’s often said that an investor’s worst enemy is himself. If our house is on fire, we listen to our intuition and run for safety. This helps us survive. However, in case of investment decisions, this behaviour can land us in trouble. The moment we see signs of panic in the stock market, we run to sell all our stocks; when we see euphoria, we jump into the market. We tend to behave irrationally and in a biased manner in many investment situations.

Your long-term investment success is determined by your ability to control your ‘inner demons’ and ‘psychological traps’. The good news is that human behaviour is irrational in a predictive manner, as examined by Professor Dan Ariely in his book ‘Predictably Irrational’. Once we recognise these ‘inner demons’, we can develop approaches to tackle them. A thoughtful investor can leverage this predictable irrationality by remaining un-swayed by the noise and making rational decisions, thereby taking advantage of others’ ‘behavioural biases’.

One of the inner demon is ‘overconfidence’. Time and again we tend to overrate our ability, knowledge and skill. Watching 24-hours news channels and listening to ‘experts’ we tend to believe that we are experts and make investment decisions that are not thought through. We think we can predict and time every up and down of daily price movements and invest accordingly.

Over confidence can lead to excessive trading and poor investment decisions. To be a successful investor, one needs to follow a zero-based approach towards decision-making. Investors need to be prudent to not sell their winners too soon and nor hold on to their losers too long.

Another important psychological trap we need to avoid is ‘herding’. People tend to follow actions of a larger group, independent of their own knowledge. Large-scale social imitation can lead to significant gaps between actual value and price. This herd-like behaviour phenomena can create profitable opportunities for individual stock. But taking advantages of collective irrationality, either for a specific stock or for the market as a whole, is difficult. Since most of us have a strong urge to be part of the crowd, acting independently is not an easy feat.

However, if we’re able to control this behaviour, it can result in significant investment gain for us. Warren Buffet sums this up by saying: “We simply attempt to be fearful when others are greedy and to be greedy only when other are fearful”. It requires significant control over one’s emotions to practice in real life.

Focus on avoiding silly behavioural mistakes

Research has shown that behavioural mistakes can reduce the return on investments by 10% to 75%. So what do you need to do avoid this? It can be summarised in one word: discipline. One need not always focus on becoming smart. Avoiding silly behavioural mistakes can help one become a successful investor in the long-term.

Key takeaway

1. Always use a ‘checklist ‘approach towards entry/exit of stock. Keep it short and reasonable.
2. It is better to do your due diligence before investing. Keep a safety margin while investing; never invest to lose.
3. Adopt a ‘buy and hold’ strategy with periodic review. The less frequently you track the market and check your portfolio, the less likely you will be to react emotionally to natural ups and downs of the stock market.
4. Be more thoughtful while taking long-term investment decision. Losing one day’s return will not matter if you want to keep the stock for 10 years. When you see sign of panic or euphoria, the best advice would be to wait for another day. If the investment is meaningful from a long-term perspective, the opportunity will continue to remain a good one, even in the future.
5. Have appropriate asset allocation, and rebalance your portfolio periodically.
6. Be humble, and learn from your mistake. When you succeed, evaluate which of your actions contributed to the success, and which ones did not. Don’t claim the credit for successes that have occurred by chance. Avoid rationalisation when you fail. Don’t exaggerate the role of bad luck in your failures.

(The writer is Managing Director at Kotak Mutual Fund)