Put your money where your financial advisor tells you and stay secure

A good financial advisor will remind us to think long-term and not get too caught up in what's happening right now. They'll help us create a plan that matches our goals and risk tolerance, so we don't make impulsive decisions based on emotions

Bas Ganit Agar Samjhaye, Chhoriye Aise Salahkar Ko Turant;

Sachcha Vittiya Sathi To Karega, Vyavhaarik Galatiyon Ka Ant.”

Translation: If all they explain is only mathematics, it's a time to trash,

A true financial partner helps avoid the behavioural crash.

The market is like a pendulum that forever swings between unsustainable optimism and unjustified pessimism-Benjamin Graham (Author of Intelligent Investor)

Understanding the swings of the market, caused by unsustainable optimism and unjustified pessimism, is beyond the scope of Mathematics. This is precisely where the role of behavioural skills assumes significance.

In the world of investing, our minds can sometimes trick us into making decisions that may not suit us best. Some common investment mistakes are made due to our behavioural biases.

Let us understand a few of them:

Confirmation bias: We tend to seek out information that confirms what we already believe, ignoring anything that contradicts it. This can lead us to make decisions based on incomplete or biased information.

Subprime mortgage crisis: Home buyers looked at a long-term trend of rising housing prices and believed that it’s a perpetual phenomenon. Loan incentives like easy initial terms and lower interest rates tended to encourage borrowers to invest. Financers lapped up the risky mortgages in the anticipation that they would be able to quickly refinance the risky mortgages. However, once interest rates began to rise (borrowers ignored the signal) – the housing prices started to drop moderately in 2006–2007 in many parts of the U.S. Eventually borrowers were unable to refinance. Defaults and foreclosure activity increased dramatically as easy initial terms expired, home prices fell, and adjustable-rate mortgage (ARM) interest rates reset higher.

Anchoring bias: We latch onto a particular piece of information and use it as a reference point for making decisions. This can prevent us from seeing the bigger picture or adapting to new information. An investor purchases 100 shares of a company at Rs. 50 per share. Over the next few months, things change, the stock price fluctuates and eventually falls to Rs. 40 per share. Instead of evaluating the stock based on its current fundamentals and market conditions, the investor anchors his own perception to the original purchase price of Rs. 50 per share. As a result, the investor may resist selling the stock even if there are valid reasons to do so, such as deteriorating financial performance or unfavourable industry trends. The investor may believe that the stock will eventually return to its original price, leading him to hold onto it longer than he should.

Herd mentality: We follow the crowd without thinking for ourselves, assuming that if everyone else is doing it, it must be the right thing to do. This can lead to bubbles and market crashes when everyone rushes in or out at the same time.

Cryptocurrencies: This is the best example of herd mentality, which is further illustrated by investments made by amateur investors in cryptocurrencies during the 2017-2018 bull run. As certain cryptocurrencies experienced rapid price increases, driven by speculative buying rather than fundamental value, more investors rushed to buy in, fearing they would miss out on potential profits. Social media platforms, online forums and cryptocurrency influencers amplified the hype, further fuelled the herd mentality.

Recency bias: This happens when we give too much weight to recent events and ignore historical data. Just because something did well recently doesn't mean it will keep doing well.

This can lead us to invest in things just because they did well recently, thinking they'll keep doing well. But that's not always true.

So, how do we avoid falling into the trap? That's where financial advisors come in. They're like guides who help us make smart choices with our money. They have the experience and knowledge to see the big picture and not get distracted by short-term ups and downs.

A good financial advisor will remind us to think long-term and not get too caught up in what's happening right now. They'll help us create a plan that matches our goals and risk tolerance, so we don't make impulsive decisions based on emotions. Plus, they can also help us avoid other tricky biases that can trip us up, like only paying attention to information that confirms what we already believe or blindly following what everyone else is doing.

In short, while it's easy to get swept up in the excitement of recent successes, having a financial advisor by our side can help us stay grounded and on track towards our financial goals. They provide the steady hand and clear thinking we need to navigate the ups and downs of investing wisely.

Benjamin Graham, one of the best known investors of the 20th Century, is bang on with his erudition, “the investor’s chief problem-and even his worst enemy-is likely to be himself.”

A true advisor keeps you away from your worst enemy, in the field of investment, which invariably you yourself are!

(The writer is Senior Vice-President, SBI Funds Management Ltd; (Translation and content by Dharmang Shah, Vice President, SBI Funds Management Limited)