‘We learn from history that we don’t learn from history’ – Desmond Tutu
It is a tendency of most, if not all, that bends us on doing investment mistakes repeatedly.
Our own ego is one that pins us down saying “how can you go wrong? It is not possible, because you are the smartest guy on this planet”. Also, media are taken as to be more authentic. With so much of news coverage, posts doing the round and information overflow, we live under the illusion – I know it all. We assume whatever that appears in media to be a certain truth; nothing less – nothing more, as we believe that they are the result of series of filters.
Because we think that this time it’s different and I will be right, enough to recover lost investments, we go on repeating the same mistake all over again. The concept of behavioural finance helps us recognize our natural biases that lead us to making illogical and often irrational decisions when it comes to investments and finances. A prime example of this is the concept of prospect theory, which is the idea that as humans, our emotional response to perceived losses is different than to that of perceived gains. According to prospect theory, losses for an investor feel twice as painful than the feel-good factor of gains. Some investors worry more about the negative marginal percentage change in their wealth than they do about the amount of their wealth. One of the biggest challenges to our own success can be our own instinctive investment behavioural biases.
Unsolicited investment tips consumed by us offered from friends, colleagues, relatives, TV channels, magazines, portals, brokerage houses, etc. may be more than harmful. Every individual’s personal and financial circumstances are unique, different from others and same investment solutions may not be suitable for everyone.
Avoiding Behavioural Mistakes
By understanding the common behavioural mistakes investors make, a quality financial advisor will aim to help you take the emotion out of investing by creating a tactical or strategic investment plan customized to the individual.
They will help you utilize investment strategies such as rupee cost averaging to create a systematic plan that takes advantage of market fluctuations or maybe a lumpsum during a temporary market downside.
The starting point of any investment plan starts with understanding your risk tolerance.
The most important aspect of behavioural finance is peace of mind. By having a thorough understanding of your risk appetite, the purpose of each investment in your portfolio and the implementation plan of your strategy, it allows you to feel much more confident about your investment plan and be less likely to make common behavioural mistakes.
Working with a financial advisor can help you recognize and understand your own individual behavioural biases and predispositions, and thus be able to avoid making investment decisions based entirely on those biases.