Behavioural Finance MI 15012011

Behavioural Finance: 

Behavioural Finance Investor Psychology

Contents: 

Company Logo Contents Common Mistakes made by people 1 What is Mental Accounting ? 2 Loss Aversion 3 Decision Paralysis 4 Anchoring 5 Fear 6 Overconfidence 7 8 Procrastination or Inaction

Common Mistakes Made By People : 

Common Mistakes Made By People

MISTAKE NO.1: 

Company Logo MISTAKE NO.1 THE FIRST & BIGGEST MISTAKE IS NOT TO ADMIT MAKING A MISTAKE.

MISTAKE NO.2 : 

Company Logo MISTAKE NO.2 BUY ON TIPS & KHABARS & WANTING TO MAKE A QUICK BUCK.

MISTAKE NO.3: 

Company Logo MISTAKE NO.3 BUYING A LOSER ON ITS WAY DOWN THINKING OF AVERAGING LOSSES.

MISTAKE NO.4 : 

Company Logo MISTAKE NO.4 IGNORING RISK ON THE INVESTMENT & LOOKING ONLY AT THE RETURNS.

MISTAKE NO.5: 

Company Logo MISTAKE NO.5 BUYING PENNY STOCKS THINKING THEY ARE CHEAPER AND IGNORING STOCKS, WHICH ARE PRICED ABOVE A CERTAIN NUMBER LIKE RS. 1000/- THINKING THEY ARE EXPENSIVE.

MISTAKE NO.6: 

Company Logo MISTAKE NO.6 EXITING WINNERS EARLY AND STICKING TO LOSERS. Winner Losers

MISTAKE NO.7: 

Company Logo MISTAKE NO.7 JUST THINKING BUT NOT DOING ANYTHING.

So what are some of common mistakes that one normally does not admit?: 

Company Logo So what are some of common mistakes that one normally does not admit? if you have made a lousy investment, recognize the mistake and rectify it. Incurring an actual loss is one of the biggest lessons that can be learnt in the equity markets. Quitting the markets is not the solution but never believing tips is certainly one of the solutions.

Lesson to learn: 

Company Logo Lesson to learn The key is to learn from them and not repeating them. However not admitting them does not correct the mistake nor will the mistake sneak out of the door quietly. Admitting one’s mistake, correcting it and learning from it will take you a lot closer to your financial goals.

What is Mental Accounting ?: 

Company Logo What is Mental Accounting ? Mental Accounting refers to the phenomenon of treating money depending on its source

How to make mental accounting work for you?: 

Company Logo How to make mental accounting work for you? Utilize mental accounting from a positive perspective : Think of all inflows that you receive as your INCOME. Don’t act immediately when you receive a windfall or an unexpected Bonus . Use cash often for purchases rather than using credit cards all the time . UNDERSTAND MENTAL ACCOUNTING AND DON’T MAKE UN-MENTAL FINANCIAL DECISIONS.

Loss Aversion: 

Company Logo Loss Aversion Loss Aversion simply refers to a concept on how our feelings about loss gets us to make unwise choices such as waiting too long to exit a losing investment or putting in more money in losing investments to average our costs. Loss Aversion can affect not only equity investments but also real estate, and business investments .

You might be afflicted with Loss Aversion if you: 

Company Logo You might be afflicted with Loss Aversion if you Want to lock a gain and not take slight risk for additional gains but the moment you see a loss; you do not mind taking EXCESSIVE Risk to avoid the loss. This is explained using the following short test. There are two portions to this test. Please check (a) or (b) for Part I and Part II. Part I (a) You win Rs.80,000. (b) You have an 80% chance of winning Rs.100,000 (or a 20% chance of winning nothing). Part II. Choose (a) or (b). (a) You lose Rs.80,000. (b)You have an 80% chance of losing Rs.100,000 (or a 20% chance of losing nothing). Don’t look for answers but answer this question honestly. Most people will answer (a) for Part I and b for Part II. If your answer is similar then you are afflicted with Loss Aversion and you need to do something about it

Decision Paralysis: 

Company Logo Decision Paralysis You are afflicted with decision paralysis if you Delay making investment decisions. Cannot decide between investment choices to be made. Even after you have invested, you are still confused. Wait for the market to fall to buy stocks and equity mutual funds but never end up buying at lower prices. Speak to 10 different people before making purchase or investment decisions but end up doing nothing

Anchoring: So what exactly does it mean?: 

Company Logo Anchoring: So what exactly does it mean? Eg. “My flat is much better than the one Sharma’s sold for Rs. 50 Lakhs. I should get atleast Rs. 55 Lakhs ” exclaimed Mrs. Kulkarni. Mrs. Kulkani was being offered Rs. 48 Lakhs but she wanted more as she strongly believed that her flat was much better than Sharma’s and could fetch a higher price than Rs.50 Lakhs. This is a classic phenomenon that happens when you either sell real estate or buy real estate. The buyer and the seller are generally anchored at a price. Anchoring is one of the most difficult phenomenons in behavioral finance to overcome. It’s a term used to explain how we are often holding on to some fact or figure and use it as a reference point to make future decisions. Mrs. Kulkarni in the above case just held on to the fact that one flat has been sold for Rs. 50 Lakhs and she should get atleast that much or more.

You might be afflicted with Anchoring if you: 

Company Logo You might be afflicted with Anchoring if you Do things just because others are doing or because your parents , friends or colleagues have said so. E.g. In the US ,it’s a common habit to tip 15 % at restaurants , airports , taxis etc. No one knows why 15 % and where did practice originated from but majority of the people follow it diligently. They are anchored to the figure of 15 %. Ask yourself the following : Am I being realistic? A rocking stock and real estate market generally put unrealistic numbers in people’s mind. When this happens, the focus shifts from risk-returns to returns only. This is a dangerous situation to be in so always keep your feet on the ground and be Humble.

Fear and how does it impact our investment strategy: 

Company Logo Fear and how does it impact our investment strategy Here are a few things to consider to address your fears. Focus your mind on some other activity. When you feel the heat or pressure, go to the gym or for a walk, play with your kids, listen to music, watch movies or go for a romantic dinner (Though these things might sound trivial , they work in real life as we are all human beings with different emotions working on us) Be Positive : Like Anil Kapoor repeatedly said in “No Entry” , tell yourself “Be Positive” and ask yourself the following questions “Does a drop in prices mean doom or a Sale? If I was confident to buy this investment at a higher level , shouldn’t I be doing it now? How did equity investments behave post the fall of 2004, 2006 and if so what has happened 1,and 2 years down the line ? Would I have done better if I had sold out or held on to my investments? Understand your Investor Feelings Quotient (IFQ). Do you feel scared to death when prices go down? How do you feel when prices go up continuously? Crunch numbers and see how you would have performed or have performed when you bought during times of excellent optimism or great pessimism. Your responses will point you in the right direction. Act CONTRA : This means that do not flock with birds of any feather. Your situation is completely different from the other person or family’s. Do not take your decisions to exit based on what others may seem to do.

Overconfidence: 

Company Logo Overconfidence You are overconfident if you think : You can time a stock or Time the market and consistently make money. Sure you might be lucky once but that does not give you this midas touch . Real Estate is the best investment and there is no way one can lose money in a real estate transaction. Investing in generally what you know is a recipe for success. You have made a wise decision by buying an investment oriented life insurance policy despite someone telling you term plan is the way to go. You can identify the next Infosys of the market but can easily explain the dud choices you have made. You don’t need an advisor.

Procrastination or Inaction: 

Company Logo Procrastination or Inaction Procrastination or Inaction is one of the biggest reasons for investors not achieving their financial goals, for lower returns and losses. So why do people really procrastinate? There are several reasons why people delay or do not action even when things are in their economic interest 1.Caught up in many activities and action takes a backseat. 2. Not able to decide. 3. Do not have time. 4. Inertia 5. Laziness 6. Lack of Understanding. What should one do to overcome this? Read the book “First Things First”or“The Power of Now” and if you want a quick read , go for the Executive Summary of this book that can be read in 20 minutes. This could probably help in terms of introspection on your priorities and things that you might need to focus on. If none of the above work, then continue with what you have been doing and “ Hope for the Best ”. Finally it is doing that makes all the difference. There is no substitute for action. Just knowing that exercise is good will not keep you fit. In the same vein, just knowing this investment is good is of no use unless you buy it.

Hot Tip: 

Company Logo Hot Tip .

Slide 24: 

Thank You ! ANY QUESTIONS