Behavioral Biases that Can Hurt Your Mutual Fund Investments | Mutual Fund Investment | IndiaNotes.com
In order to achieve long-term financial goals, investors tend to choose different avenues to park their money. With declining rates on fixed deposits (FDs), investors look for alternative options that mayhelp maximize their wealth.
Not many investors are aware of the features of different investment options. A number of factors play a role in their decision to invest and one of the prominent factors is behavioral bias.
Behavioral biases that impact investment decisions
Investors tend to get caught up in their emotions and analytical mind. Although investing is considered to be purely logical, there are a number of factors that dominate the decision. Some of the biases that analysts have identified,which have had an impact on the decision-making ability of the investor, are as follows:
• Loss aversion bias
Losing money is more painful for an investor than feeling pleased to win an amount. When an investor loses money, he tries to limit the losses to a minimum. This causes many investors to untimely withdraw funds from an investment, when there is a temporary market crash. This is an irrational decision and may cause a significant loss of investment. Had they remained invested, they could have had their money back in the subsequent period.
Many investors are overconfident about their ability to predict the market movement. They tend to make decisions based on their market analysis, which may or may not be true. When the market is high, investors feel that it will go higher and end up purchasing securities at a higher cost. It is important to remember that overconfidence mayalso lead to losses and any investment should only be made after a thorough research and analysis.
• Recency bias
This occurs when investors think that the current market movement will remain the same in the future as well. Predicting the long-term performance of the market based on a current event may lead to irrational decisions. Every market is prone to highs and lows, but the cycle varies in the long run. Staying invested for a long duration ensures higher return and smoothens out the impact of the market volatility.
• Confirmation bias
Many investors take decisions based on their opinion of the market and the fund they are investing in. Since they have an opinion on the market, they look for information that will confirm their opinion and tend to ignore information which does not confirm their opinion. As a result, it often happens that investors fall for the low-performing funds and remain indifferent to the good funds.
• Herd mentality
A herd mentality is applicable across every industry. If a large number of investors are investing in a particular stock or company, others follow their footsteps. This is because of the belief that since many investors are making their investment in a particular stock, there are higher chances that it is a good fund and will grow in future.
• Sunk cost bias
This is applicable to investors who have already invested in mutual funds. If a fund is underperforming, they are unable to exit the same because they still have a ray of a hope that the mutual fund investment will perform better in the future. This hope of a higher return makes them hold the investment intact for a longer duration.
• Choice paralysis
Investors have a number of investment avenues and a number of funds to choose from. With more mutual fund investment choices, there is difficulty in making an appropriate decision and investors are unable to zero in on one instrument. In order to avoid this, investors need to study all the options and understand the figures before making an investment.
The logic applied by an investor maybe his/her worst enemy. Due to a large number of behavioral biases, they end up making the wrong choices and regretting later. The best way to make an investment decision is to lay out a rational and realistic long-term financial plan and determine the tenure of investment in the same. Investors prefer mutual fund investment due to the higher returns and low risk associated with it. The fund is managed by a professional fund manager who strives to diversify the portfolio and increase long-term returns. Alternatively, investors mayeasily invest in mutual fund online and manage their portfolio.
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