Category Archives: Behavioral Finance

We all know that temperament is one of the most important quality not only in the investment field but also in our life. If we work on our emotional biases then we can win any battle. To excel in temperament, first, we need to be aware of the various biases. So now onwards, I will illustrate various biases and how we can excel it and use it in our life. This entire series will be review with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly”.

WHY YOU SHOULD SET FIRE TO YOUR SHIPS Inability to Close Doors

Posted on by under Behavioral Finance

Many times, we have to choose some options and that option seems to be free of cost. This is an illusion, however. They also come at a price, but the price tag is often hidden and intangible: each decision costs mental energy and eats up precious time for thinking and living.

We want to achieve everything and that ended up with nothing to us. Sometimes we need to learn to say no to the majority of things.

Investment – When we do not have an investment process then we like every stock and feel regret when we missed any. When we prepare a process, we show readiness to say no to the majority of things and accept things that fall under our process.

I have seen many investors who try to capture every opportunity, and when they cannot capture any, then they fall to regret. If we keep saying “yes” to every opportunity then we cannot smell the difference between real and fake opportunities. We cannot buy all listed stocks on the Indian stock exchange. And for that, we have to create a process that is suitable for us.  

Think hard once and then just consult your list forever, instead of having to make up your mind whenever a new door cracks open. Most doors are not worth going through, even when the handle seems to turn so effortlessly.

This entire series will be reviewed with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.

WHY FIRST IMPRESSIONS DECEIVE Primacy and Recency Effects

Posted on by under Behavioral Finance

We get more attention to what we hear, observe, and talk about first, and that work as a belief creator among us. This bias is known as the primacy effect. That’s defined by the well-known saying – “first impression is the last impression”.

The primacy effect is not always the culprit; the contrasting recency effect matters as well. The more recent the information, the better we remember it. This occurs because our short-term memory file drawer, as it were, contains very little extra space. When a new piece of information gets filed, an older piece of information is discarded to make room.

Investment – First and last both Impression matters so that when we read annual reports, many companies make it attractive to create a first impression. Later on, they try to hide the truth between the first and last impressions. We have to be very careful while we read any information rather than get biased with primacy or recency effects.

This entire series will be reviewed with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.

WHY ‘LAST CHANCES’ MAKE US PANIC Fear of Regret

Posted on by under Behavioral Finance

The fear of regret can make us behave irrationally. To dodge the terrible feeling in the pits of our stomachs, we tend to act conservatively, so as not to deviate from the crowd too much.

When he/she refuses to make any decision because of the fear that the decision will turn out to be wrong and then may later lead to feelings of regret. The emotional process behind this is pretty simple. Regret causes emotional pain. Hence, the brain tries to avoid making decisions that cause regret.

Regret is an emotion, and it is also a punishment that we administer to ourselves. The fear of regret is a factor in many of the decisions that people make (“Don’t do this, you will regret it” is a common warning), and the experience of regret is familiar. Intense regret is what you experience when you can most easily imagine yourself doing something other than what you did.

Investment – Due to regret, investors keep chasing fancy and hot stocks so that they do not remain outside of the crowd from earning good returns. Also, they run for catching every available opportunity so that they do not regret missing out on an opportunity. People feel that it’s the last chance and if they do not buy right now, then they will miss an opportunity. This fear creates panic and makes them helpless to buy whatever is available.

It’s your last chance! This thought races through head, you give in and buy the last plot at an exorbitant price. The fear of regret tricked you into thinking this was a one-time offer when in reality, an opportunity will always come on the market.

Due to regret, the fund manager tries to maintain a similar kind of top holding to match the broader market return. If they are not able to match, then they feel regret for being left out.

People generally try to take profits available with their investment so that if the price falls, then they do not have any regret of not taking profits. For reducing regret, we should prepare a circle of competence and prepare an investment philosophy so that opportunity that falls outside of it can be easily avoided and help to reduce regret. We should understand that Mahendra Singh Dhoni cannot sing like Late Lata Mangeshkar. So that we should define our area of competence and outside of it never bother us.   

This entire series will be reviewed with various examples from books which are “Thinking, Fast and Slow” and “The Art of Thinking Clearly“.