Volatility often brings out the worst tendencies in investors. When torn between fear and loss, the investors might get pushed into making decisions which they could regret in the future.
While some depend on expert commentary, others rely on their own decision-making skills. However, expert opinions may not always work in the favor of investors as they sometime come with certain inherent cognitive biases.
Hence, before you take any action in the current scenario, ask yourself – are you succumbing to these cognitive biases?
Investors often follow the footstep of famous investors instead of trusting their own analysis. While following the trend may work, this is not advisable as you may end up booking heavy losses.
This is especially true in a volatile market where market chatter seems more appealing that your individual analysis.
Always remember that if everyone is saying “A” while you are saying “B”, you need not be wrong. Following the trend without conducting researches can make you invest in the wrong assets or products, which eventually can lead to losses or inadequate returns.
Therefore, understanding what you invest in and why you invest in it is very essential.
Loss aversion is the tendency to avoid booking losses rather than focusing on making profits. We often focus on the risks associated with the investments instead of the potential gains.
This is solely because a small loss may overpower a large gain psychologically. When we think about change, we focus more on what we might lose rather than on what we might get. Some of the well-known examples of loss aversion are:
> Forgoing promising investments that carry marginally higher risk vs investing in low-return funds with fixed returns.
> Holding on to a particular stock despite rational analysis indicating that it should be abandoned.
To simply state, always keep in mind the big picture and builds a long-term view of your investments.
Framing Cognitive Bias
Our choices highly depend on how the information is presented to us. The same facts presented in two different ways can alter people’s judgments and decisions.
The marketing strategy of soaps is a classic example of this bias. We all have heard statements about XYZ soaps killing 99 percent germs, what they don’t state is the 1 percent germs we continue to consume on a daily basis, for which there is no counter. The idea, however, is to present statements which have a more positive impact.
This is particularly relevant for a volatile market, where you should draw your own conclusions rather than getting swayed by how the information is being presented to you.
This can be achieved by rephrasing the information presented to you and trying to kick in the logical, reflective approach towards decision making to avoid impulsive, reflexive decisions.
Sunk Cost Fallacy
Say two years ago, you bought a stock when the markets were at a high with the fundamentals and price trends looking optimistic. Now, when the markets are undergoing a volatile phase, the stock has started cracking and financials look bleak for the upcoming quarters.
If you continue investing in the stock believing it will hopefully recover its profit and costs, then you are suffering from a classic case of sunk cost fallacy.
It happens when you invest more money into a losing project because of previous investments.
Since the costs cannot be recovered, we don’t want to waste the time, effort and money spent on it and in turn keep spending more and more with a hope of getting returns someday.
Keeping track of all your investments, whether time-wise, effort-wise or money-wise and be ready to cut your losses when the numbers don’t look good can help avoid sunk cost fallacy.
Most importantly, in a volatile market, give all your dilemmas a careful consideration.
Understand how your biases are impacting you monetarily and instead of realigning your financial positions, if you work on your biases – then it will be more helpful in reducing losses and getting adequate returns.
Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.