The Signal: The Fool’s Misbehaviour
“Investments are subject to market risk. Read all scheme related documents before investing”
Nothing represents investor ignorance better than the above statement. Let me fix it for you –
“Investments are subject to risks even beyond the market. Only reading scheme-related documents will not help you mitigate those risks.”
Writers love to talk about fancy-name-ratios and how it indicates risk. Journals and columns love to rave about risk indicators more than the risk. In fact, most do not even dare tread beyond diversification to mitigate risk.
But, here’s the bomb – market risk is NOT the biggest risk.
You know market risks exist. You invest with an understanding that this risk may materialise, and you can incur a loss.
But what if there is a risk that you are completely unaware of?
Or even worse – you are aware of the risk yet continue to be a helpless victim?
Behavioural risk is the most underrated risk!
Even the most intelligent investors succumb to behavioural risk – especially during volatile times like now. While behavioural risk is an expansive subject, here are the three most critical and common behavioural fallacies among investors.
#1: The Investor’s Ego
There’s a popular notion about the investor’s ego – the moment a person buys his first equity share, he/she contracts this behavioural virus known as the Investor’s Ego. Symptoms include being excessively confident about own’s own rationale, ignoring conflicting opinions and in extreme cases – a tendency to compare oneself with Warren Buffett (or the other way round).
Often, investors refuse to accept own decisions as wrong and continue with futile attempts to make good of the situation. The inability to see beyond one’s ego is a prime reason for fractured relationships & broken investments.
Most long-term equity investments started out as an intraday trade gone wrong!
#2: Paying Attention
Don’t get this wrong. Paying attention is important; paying attention selectively is lethal.
“South-Asian Paints’ market share in Mumbai goes up from 30% to 35%. The company’s WACC has increased to 18% in just three quarters. Analysts note, the stock price has been exhibiting a continuous increase in the beta and standard deviation over the three quarters.”
Now, just because the investor itches to act upon newfound knowledge, they log into their trading account.
What do you think happens next? Is it a buy or sell? What would you do?
Hold onto that thought.
Most investors (academically & professionally unrelated to finance as a subject) read the above as –
“Increase in market share… blah-blah … increase to 18% in just 3 quarters … blah-blah-blah … continuous increase … blah … three quarters”.
Is this how you read it?
If yes, let us take a wild guess about your investment decision.
Was it a “buy”?
Here’s how paying attention selectively can backfire. As humans we tend to retain only the things we understand and base our decisions on the information our memory retains.
Here, it is simple to understand that the company’s market share has increased (which is a good thing) and then we read through some more mumbo-jumbo that talks about an increase – so we presume this is also a sign of progress.
Here’s where things go wrong, and this is how wrong investment decisions are made.
For the curious, the other two increases were referring to an increase in cost and increase in risk (which is not a good thing!).
It is okay to pay attention selectively if that piece of information has no role in your investment decisions.
#3: The Itch
Drawing from the above illustration, the investor can still do well if he stops at paying attention selectively. The real problem begins when he acts on it.
This itch to act upon newfound information is also popularly known as action bias.
“Charlie and I decided long ago that in an investment lifetime it’s just too hard to make hundreds of smart decisions. That judgement became even more compelling as Berkshire’s capital mushroomed and the universe of investments that could affect our results shrank dramatically. Therefore, we adopted a strategy that required our being smart – and not too smart at that – only a very few times. Indeed. We’ll now settle for one good idea a year.”
– Warren Buffett
Investors need to find solace in the fact that not acting upon something is also a conscious action. While this may seem straightforward, most investors are vulnerable to this behavioural risk. If you are considering investing, switching or redeeming any of your capital market investments because of the current volatility – that’s a prime symptom of the itch!
Do not be a fool. Do not misbehave.
Each time you feel like tweaking your portfolio, wash your hands for 20 seconds and utilise the time to think about this –
A theory suggests that oxygen absorbed during respiration damages cells through oxidation which leads to aging and consequently death. In a way, the elixir of life is also the kiss of death. (Now you know why they recommend antioxidants in diets!)
Is it possible that your paranoia about financial security led you to making great investment decisions and the same paranoia will push you to overdo it and ruin the fort you built?