Investment articles | Assetmultiplier

17 Jun

Beginners’ guide to investing…

“Bro, suggest me some good stocks please.”

“Hey, I heard stock X is going to go up, should I buy it?”

“I want to start an SIP, how to do it?”

“So, like can you double my money?”

As a 20 somethings guy working in the financial advisory industry, I have had my fair share of interactions mentioned above. Somehow you become the de-facto person in your circle whom people confer for financial advice. In this series of articles, I’ll be sharing some of the very basics of Investing for any beginner who has very little information about how the system works. Be advised that this is a very generalised heavily simplified version and the actual actions may differ on a case-by-case basis. Let’s take a dive into the world of bulls and bears, shall we?

The Difference Between Saving and Investing: A common misconception amongst first-time investors is that both are the same. However, there’s a critical difference between the two. Savings, in essence, are any money that you don’t spend from your earnings. For eg. On a salary of Rs. 50,000/- per month, a person is left with around Rs. 20,000/- every month, those are their savings. Investing is when you allocate these savings with the expectation of generating income and wealth. An example, of the Rs. 20,000/- saved the person buys Mutual Funds of Rs 10,000/- and Rs. 10,000 in a bank FD, only then can it be considered investments.
Set Goals: It might feel like a boring and tedious task, but a lot of investment decisions are based on the person’s financial goals, their risk appetite. The first step before investing is asking questions, why am I doing this? when/how will I be using this money? To appropriately assess investment options.
Safety Cover: A critical aspect before starting the investment journey is deciding on an adequate safety cover. It is generally advised to have at least 6 months of your expenses stored away in a rainy-day fund; any unexpected setbacks should not deter an investor from their investing goals. Unexpected illnesses/ accidents or death are the biggest threats to an investor’s long-term investing goals as they can cause wealth erosion pretty quickly. Investors should adequately Insure themselves before investing.
Discipline: Investing has very little to do with markets and everything to do with behavioural impulses. It’s easy to start investing, it’s difficult to keep investing and it’s hardest to stay invested. Many first-time investors lack the discipline to consistently keep investing, but persistence is the only thing that generates wealth in the long term. Another trap most first-time investors fall for is consistently checking their portfolio for gains and losses, which is as unpredictable as the wind blowing and are tempted to cash in on their investments for short-term gains or stop investing altogether because of losses. Discipline wins in the end.
Uncertainty: Like all things in life, Investing too is unpredictable and difficult to understand at times. Not every investment will give an investor their desired returns, nor does an average investor have the time and skills to analyse their investments periodically to take corrective actions. In order to mitigate the risks, it is recommended that investors confer with SEBI registered Investment Advisors to guide them through their investing journey.

This is the 1^st Part of the Introduction to Investing Series, which will discuss critical aspects of investing aimed at first time investors. Stay tuned for more.

Disclaimer: “The views expressed are for information purposes only. The information provided herein should not be considered as investment advice or research recommendation. The users should rely on their own research and analysis and should consult their own investment advisors to determine the merit, risks, and suitability of the information provided.”

By Pratik Mate Investment articles #Personal Finance, investing 0 Comments Read more...

09 Jun

What We Should Remember About Bear Markets: Part II

(In continuation with the previous article…)

Some losses won’t be temporary: For sensibly diversified, long-term investors the losses from most bear markets should be temporary (there is a long-run premium attached to equity investing after all), but investors should not naively assume that everything will recover. Imprudent investment decisions will be exposed in bear markets. Inappropriate leverage, unnecessary concentration, and eye-watering valuations tend to bring about permanent losses of capital that time will not heal.

Emotions will dominate: The ability to make good, long-term decisions during a bear market is severely compromised. The emotional strains that investors are going to feel will outweigh rational thought – what happens if things continue to deteriorate and they do nothing? It is during such times that systematic decision-making – such as rebalancing and regular saving – comes to the fore.

Risk tolerance will be examined: Bear markets are the worst possible time to find out about one’s tolerance for risk. Everyone becomes risk-averse when they are losing money. The issue for investors is that experiencing a 37% loss in real life is very different from seeing it portrayed as a hypothetical situation. If possible, investors should avoid reassessing their appetite for risk during tough periods.

Investors will extrapolate: During a bear market, it’s difficult to perceive anything except doom and gloom. Investors might believe that things will keep getting worse – prices will be lower again tomorrow.

Each bear market will be different: Investors should ignore all charts comparing current declines with other bear markets in history, they are entirely unhelpful. There is no reason to believe that such a deeply complex, unpredictable system should mimic patterns of the past. Each bear market is unhappy in its own way.

Bear markets are the ultimate behavioral test: The outcomes of bear markets are more about investors than they are about the market. Investors entering a bear market with identical portfolios will have wildly different results based on the decisions that they make during it.

Source: ‘What We Should Remember About Bear Markets’ by Joe Wiggins published on behaviouralinvestment.com

Asset Multiplier comments:

It is difficult but necessary to remain a long-term investor during bear markets. During times of uncertainty, investors should resist allowing their emotions to influence their rational decision-making.
Rather than chasing winners or trying to time the market, investors should concentrate on rebalancing their portfolios and keeping them steady.
Accepting that stock markets have ups and downs is a key element of investment discipline. This helps investors protect their capital and maintain their calm amidst turbulent markets.

By Rutuja Chavan Investment articles bear markets, volatility 0 Comments Read more...

02 Jun

What We Should Remember About Bear Markets: Part I

The following article is taken from ‘What We Should Remember About Bear Markets’ by Joe Wiggins.

Bear markets are an inescapable feature of equity investing. They are also the greatest challenge that investors will face. This is not because of the (hopefully temporary) losses that will be suffered, but the poor choices investors are liable to make during them. Bear markets change the decision-making dynamic entirely. In a bear market, smart long-term decisions often look foolish in the short-term; whereas in a bull market foolish long-term decisions often look smart in the short term.

If investors are to enjoy long-run investment success, they need to be able to navigate such exacting periods. There are certain features of bear markets that it pays to remember:

They are inevitable: Bear markets are an ingrained aspect of equity investing. Investors know that they will happen; they just cannot know when or why. Their occurrence should not be a surprise. The long-run return from owning equities would be significantly lower if it were not for bear markets.

It will feel predictable: As share prices fall, hindsight bias will go haywire. It will seem obvious that this environment was coming – the warning signs were everywhere. Investors will heedlessly ignore all the other periods where red flags were abundant and no such market decline occurred.

Nobody can call the bottom: Market timing is impossible, and this fact does not change during a bear market. The only difference is the attraction of attempting it when falling portfolio values can become overwhelming, and the damage it inflicts will likely be greater than usual.

Economic and market news will be conflated: The temptation to interlace economic developments with the prospects for stock market returns can become irresistible during a bear market. Weak economic news will make investors increasingly fearful about markets, despite this relationship being (at best) incredibly hazy.

Time horizons will contract: Bear markets induce panic, which shortens time horizons dramatically. Investors stop worrying about the value of their portfolio in thirty years and start thinking about the next thirty minutes. Being a long-term investor gets even more difficult during a bear market.

Investors don’t consider what a bear market really means: In the near-term, bear markets are about painful and worry-inducing portfolio losses, but what they really are is a repricing of the long-run cash flows generated by a business / the market. The core worth of those companies does not fluctuate nearly as much as short-term market pricing does.

Lower prices are good for long-term savers: For younger investors saving for the long-term, lower market prices are attractive and beneficial to long-run outcomes (it just won’t feel like it).

Source: ‘What We Should Remember About Bear Markets’ by Joe Wiggins published on behaviouralinvestment.com

Asset Multiplier Comments:

Losing investment plans during bear markets is inevitable. Although difficult, long-term investors should sit through such exacting periods patiently and stick to their investment approaches.
Investors can use bear markets to their advantage by accumulating quality stocks at cheaper valuations and profiting from long-term gains.
Investors should avoid getting consumed by noise and immediacy and focus on building wealth over the long term.

By Rutuja Chavan Investment articles bear markets, investing 0 Comments Read more...

27 May

Slow and Steady wins the Race

The most common excuse that people spell out when explaining the benefits of investing in a disciplined manner is not being able to save money by the end of the month. When it comes to investing, one need not wait till the time one can accumulate a lump sum to take the first step into investing in the stock market. Even saving Rs. 1,000 a month and investing in an equity-linked mutual fund, may accumulate lakhs a few years down the line. This form of small but periodic form of investment is called Systematic Investment Plan (SIP). One way of saving for investments is by cutting down unnecessary expenses.

A penny saved is a penny earned.

This age-old adage is the mantra for wealth creation. This is why budgeting becomes an important exercise. Most people spend first before they even think about saving, which is not a very helpful approach to savings or investing. Instead, follow the hierarchy of Earn – Save – Spend and these savings can be channelized into an investment product. Within the investment product universe, one of the options which aid long-term wealth creation is investing in an equity-based mutual fund for one’s long-term goals. The beauty of this approach will become apparent only after a couple of years when there is a neat sum gathering in one’s account, thanks to the market-linked gains that the investment may be accruing, all of which is an enriching experience. Just monitoring it and seeing it grow makes investors confident of their improving financial condition. As a result, investors tend to automatically start spending less and invest more.

SIP versus EMI.

Most people who find it hard to save and invest would happily purchase expensive items in debt. Paying EMIs (Equated Monthly Instalments) to buy a new car or a phone feels easier than investing some amount gradually to afford it in one go. Steer clear of instant gratification. It is better to start an SIP than to shell out money on EMIs. SIPs are the best EMI one pays. There is no point in paying interest on luxury. It is better to become rich enough to afford luxury.

Why SIP matters

The stock market is volatile. One day it is on an upward journey, but the tide may turn the next day. Investors should avoid predicting the stock market moves. With SIP money gets invested at different market levels that will support one’s portfolio when there is a sudden market crash. The portfolio will not crash the way individual stocks or the benchmark indices like Sensex and Nifty may crash. SIP is a weapon to tame market volatility.

Compounding is the eighth wonder of the world. The longer one stays invested and runs their SIPs, the higher rewards they earn. For example, Rs 5,000 SIP each month will give Rs 11 lakh after 10 years at a compound annual growth rate of 12 percent. Continue it for another 10 years, and it will become Rs 46 lakh. One can start an SIP for short-term goals also. However, the selection of investment products will change accordingly. Investors should always align their investment strategy with their financial goals and timeline.

To conclude, one should believe in the power of SIP where one can start small to make their bigger dreams come true. Slow and steady wins the race – the timeless moral of the Tortoise and the Hare story cannot be timelier in the current market scenario. In an era of quick money-making where everyone is behaving like a rabbit, be a tortoise to beat them all.

Source: ‘Slow and Steady Wins the Race’ by Kapil Holkar in the October 2021 issue of Outlook Money

Asset Multiplier comments:

SIPs help investors reduce their portfolio risk, contain emotional biases, and are a disciplined approach to investing.
The longer one stays invested and runs their SIPs, the higher rewards can be earned due to the effect of compounding. The sooner one starts, the more time there is for the invested money to produce results.
SIPs differ across time horizons and risk profiles. Investors can achieve their short-term, medium-term, and longer-term financial goals by investing in SIPs in one go rather than choosing to pay EMIs.

By Rutuja Chavan Investment articles savings, SIPs 0 Comments Read more...

18 May

How to Deal with the Behavioural Challenges of Bear Markets

It is at times of severe market stress that investors’ worst behavioral impulses come to pass. Whilst the recent losses in the value of portfolios are undoubtedly painful; the poor decisions that investors will make as a result of the blazing environment will likely prove more damaging to their long-term outcomes.

Against such a turbulent market backdrop, which behavioral issues should investors be most concerned about?

Myopic Loss Aversion: Short-term losses are difficult, but they are also an inevitable feature of investing in risky assets. Indeed, the high long-term returns from equities investments are a result of their volatility and the risk of significant losses; in order to reap the benefits, investors must be willing to endure difficult periods. For most investors (particularly younger ones) it makes sense to reframe the issue – rather than markets falling steeply, they should think about the likelihood that long-term expected returns from risky assets are now materially higher.
Recency: Obsession with recent and salient issues means that they overwhelm one’s thinking. Whether it is wars, inflationary pressures or coronavirus. This is not to say that such issues are not important but from a long-term investment perspective, they are less vital than one thinks and feels they are at the time. Investors should make investments such that they would have to leave them untouched and unseen for the next ten years.
Risk Perception: Investors are poor at judging risks. They are prone to ignoring certain threats whilst hugely overstating others. Their judgment about the materiality of risk tends to be driven by its availability (how aware they are of it) and its emotional impact on them. The Russian invasion of Ukraine is a particularly damaging risk for investors because the magnitude of the impact is highly uncertain and it is deeply important. Investors also need to be clear about what risks they are considering when making an investment decision – is it the risk of short-term losses, the risk of being whipsawed by volatile markets, or the risk of failing to meet their long-term objectives?
Narratives: Although investors should be driven by evidence, many of the investment decisions they make are founded on convincing stories. In times of profound uncertainty, this flawed feature of one’s decision-making becomes highly problematic. It is incredibly uncomfortable to acknowledge that investors have no clarity around a major issue such as the Russia-Ukraine war; so, they construct stories to relieve their discomfort. These narratives help them ‘understand’ what has happened, but also, more damagingly, give them undue confidence about what will happen in the future. It is better to admit not knowing an issue, rather than concocting a story.
Overconfidence: In the past three months everyone has become an expert in diplomacy and economics, despite having no previous grounding in the subject. It is okay to have an opinion, but the vast majority of people are guessing, and nobody knows the near-term market or economic impact of the war. Investors shouldn’t make investment decisions that suggest they do.

In these environments, making sensible long-term investment decisions is highly likely to leave one looking foolish in the short term. This doesn’t mean one should not make them. The advantage of being able to invest for the long-term is at its greatest when it is the hardest thing to do. The only way to benefit from this is to have a sensible investment plan that is clear about objectives and the decision-making process. Sticking with this through tough times can provide a major behavioral edge.

Source: How to Deal with the Behavioral Challenges of Bear Markets by Joe Wiggins behaviouralinvestment.com

Asset Multiplier Comments:

In these uncertain times, the only thing investors can control is their investment process. So, investors should try not to get consumed by immediacy and noise.
One advantage of bear markets is that they allow you to buy quality stocks at high margin of safety. Fundamentally good companies tend to perform better in the long run so buying them at cheaper valuations may turn out to be advantageous.
Diversifying investments across various asset classes and sectors may help investors contain their portfolio risks.

By Rutuja Chavan Investment articles INFLATION, war 0 Comments Read more...

12 May

The Myth of Consistent Outperformance

In the active fund management industry, there is no better sign of investment insight than to overcome the odds and produce excess returns with unfailing regularity. This notion is bogus because patterns of consistent outperformance are exactly what one would expect to see if results were entirely random. This measure alone tells us nothing and believing in it would lead investors to an array of investing mistakes.

The careers of most star fund managers have been shaped by seemingly rare runs of good form. Performance consistency is also often used as a tool for rating and filtering active fund managers – with skill linked to how regularly they beat their benchmarks over each year/quarter/month. To think that the delivery of regular benchmark beating returns is indicative of skill, investors need to believe one of two things:

For a fund manager or team to outperform consistently, investors must suppose that they can accurately predict future market conditions. Without having this ability, it is impossible to position a portfolio to outperform in a constantly evolving environment.
Financial markets will consistently reward a certain investment style. If investors do not accept the first notion, then they must believe that a fund manager has a flawless approach that always outperforms- regardless of the market conditions.

Stories over randomness

The existence of consistent outperformers is almost certainly the result of fortune rather than skill. In any activity where there is a significant amount of randomness and luck in the results, outcomes alone tell one next to nothing about the presence of skill. The only way of attempting to pinpoint skill is by drawing a link between process and outcomes. In order to claim performance consistency is evidence of skill, one should justify the part of the process that leads to such unwavering returns.

Consistently poor behavior

The obsession with performance consistency is not just a harmless distraction, but an issue that leads to poor outcomes for investors. There are three main problems:

It leaves investors holding unrealistic expectations about what active funds can achieve. A rule of thumb to follow- if a fund has outperformed the market for five years straight, then at some point it will underperform for five years straight.
Buying funds that have shown unusually strong run of performance leads to entering markets at expensive valuations. Markets tend to converge to their mean values over time and by walking into expensive valuations investors may have to sit through painful mean reversion.
Narratives surrounding consistent outperformance promote the glorification of star fund managers.

Source: The Myth of Consistent Outperformance by Joe Wiggins on www.behaviouralinvestment.com

Asset Multiplier Comments

Fund investors should focus on the consistency of the philosophy and process of a fund manager. In an unpredictable environment, one’s investment approach is the only thing that can be controlled.
Believing that consistent outperformance is the evidence of skill can lead to capital erosion.
Instead of chasing active mutual funds, investors can go passive. Sticking to this approach in a disciplined way will ensure slightly better performance than active funds over the long run as fees are comparatively lower.

By Rutuja Chavan Investment articles mutual funds, outperformance 0 Comments Read more...

06 May

A few basic questions…: Part II

(In continuation with the previous article…)

Where should investors spend their time?

Investors should focus on that sweet spot. They can revisit each business that’s near buyable levels, to make sure they don’t miss anything on risk and quality. While evaluating their buying opportunities, investors should also explicitly check if they are being too cheap. Investors should be prepared to buy at a price that strikes a balance between losing money and missing opportunities.

What will happen in the short run?

Anything. It is impossible to predict what will happen in the short run. Investors can keep revisiting these basic questions at every price level for their consideration set. There is no investment process that can reliably deliver good short-term results. Aiming for good short-term results jeopardizes good long-term results. One side benefit of sticking to safe and good is that one is less likely to question business fundamentals just because price tanks. In weaker businesses that periodically require kindness of strangers, reflexivity complicates life.

What will happen in the long run?

Across decisions, one should hope for outcomes that are better than bad, with wipe-outs being rare. In aggregate, investors hope for satisfactory returns, both absolute and relative. But they are far from certain and there’s a decent chance they won’t work out at all. Investors’ assurance is a vague comfort drawn from history and experience. Even if it works out, the long run can turn out to be painfully long.

What will one miss?

A lot. It’s not possible to catch every great opportunity of the coming decade. There will surely be icky banks and dodgy unicorns among tomorrow’s rockstars. Many a 50 PE will look cheap in hindsight, like in those cherrypicked back-tests. Investors should not aim to capture every likely winner. They should aim to do their best within what works for them.

More generally, the focus is central to any sensible method. Investors should zoom in on a subset of opportunities that fit into their way of thinking. What’s left out is usually way larger than what’s in. Straying outside their focus area implies that investors either don’t have a method or will implement it poorly. Living with FOMO (Fear of Missing Out) and envy is part of investing process.

How do these questions help?

Reassurance. Everyone knows what to do. The problem lies in sticking to it in scary times. If investors are at peace with their chosen approach, they’re less likely to lose their nerve or try to become someone else. Explicitly going back to basics helps one be more at peace with one’s chosen approach and act in line with it. Investors should avoid getting consumed by immediacy and noise.

Source: A Few Basic Questions from www.buggyhuman.substack.com By Anand Sridharan.

Asset Multiplier comments:

Investors should revisit the above-mentioned questions to stay aligned with their investment process.
Aiming for short-term results hinders the process of long-term wealth creation.
Instead of evaluating every winner, filtering out stocks that don’t match one’s investment strategy reduces the size of the stock universe and strengthens conviction.

By Rutuja Chavan Investment articles conviction, investment process 0 Comments Read more...

28 Apr

A few basic questions…: Part I

The following article is taken from “A few basic questions’ by Mr. Anand Sridharan who is an investor at Nalanda Capital.

In stormy seas, it’s good to revalidate what ones true North is. Investors can do this by asking themselves basic questions about how they think about investing & what that implies for how they should act now.

Each investor has an investment process that hopefully (a) gels with who they are, and (b) works over the long run. Revisiting principles of that process can help clear the mind in murky times and strengthen conviction to act on the implications of that process.

The author has listed some basic questions and what they mean to him to illustrate his process. Below are some of the questions whose answers would be different as each investor operates under different contexts, constraints, and preferences. What matters across everyone’s answers isn’t correctness but internal consistency.

What is one trying to do? The author intends to indefinitely own safe and good businesses purchased at reasonable valuations. To further elaborate on this, Safe means avoiding things that resemble bad people or bad neighborhoods or things investors can’t figure out. It is better to avoid than price big risks. Good is partly quantitative. The author’s primary metric is the return on capital. Over 20% for over five years is his rough bar. Investors should incline toward a business that has strengthened its competitive position within its industry. The qualitative part involves a construct where goodness is likely to sustain.

If the author is correct about safe and good, his consideration set is confined to enterprises that are above average. Purchasing goods at near-par or slightly above-par prices appears sensible. A relevant reference point for determining what is par is that the average business has historically been valued at a mid to high teens multiple of earnings over time. Valuation discipline is to avoid disastrous outcomes when investors are wrong or something unexpected happens.

What should one try not to do? Within what’s safe and good, the investors should not: 1. Pay any price just because they really like a business. 2. Wait for an unreasonably cheap price either.

Where does the current environment leave one on what to do and not do?

Everything’s fallen in price but a lot of it isn’t actionable. Bad businesses getting beaten down doesn’t help (e.g., bad bank below book). On the opposite end, 80 PE falling to 50 PE for a ‘great’ business doesn’t help one either. Valuations for the author’s consideration set are mostly ‘less outrageous but too high for his comfort’. In the middle, a (small) sweet spot of safe enough, good enough, reasonable enough is emerging.

Source: A Few Basic Questions from www.buggyhuman.substack.com By Anand Sridharan.

Asset Multiplier comments:

Abiding by one’s own investment process in a disciplined way is the simplest way of wealth creation over time. Staying undaunted amidst noise and chaos is the key to remaining invested over the long term.
Investors should be willing to pay a price that finds a balance between losing money and missing out on a good deal.

By Rutuja Chavan Investment articles portfolio, valuations 0 Comments Read more...

20 Apr

Via Negativa-What Should Fund Investors Not Do?

Fund investors spend a great deal of time deliberating the positive steps they can take to achieve better investment results. While this is an important endeavor, there is something easier and more effective that should come first – deciding what they should not be doing.

Nassim Nicholas Taleb highlighted the benefits of eliminating errors in his book ‘Anti-Fragile’ where he describes the theological idea of “via negativa”, which is a means of explaining God by what it is not, rather than what it is. Taleb broadened this concept to contend that it is easier and more beneficial to stop negative activities than to attempt to identify new, and constructive behaviors.

Investors can eliminate the mistakes that they know are damaging and costly far more easily than discovering positive behaviors that might improve their fortunes. The more complex and unpredictable the environment, the more likely this is to be true.

This is an approach that should be adopted by fund investors, who face an immeasurable line-up of choices and decision points. Rather than obsessing over how to define the precise allocation to the right funds at the right time – an incredibly difficult task – it would be more productive to first concentrate on the actions investors should avoid. Prioritize omission over commission.

So, what is it that fund investors should not do?

1) Don’t buy into a fund after an extremely positive performance: Abnormally strong performance on the upside is highly unlikely to persist, investing after a spell of stellar returns is an asymmetric bet.

2) Don’t be concentrated by the fund, manager, style, or asset manager: Concentration is the surest path to severe losses, it implies investors know far more about the future than they do.

3) Don’t predict short-term market movements: Investors cannot predict the short-term behavior of markets or funds that invest in them. Hence, they should avoid basing their decisions on expected short-term market movements.

4) Don’t check short-term fund performance: Short-term fund performance is typically nothing more than random noise, checking it frequently encourages poor decisions.

5) Don’t use performance screens: Using performance screens will highlight the funds which have done well historically. As fund performance tends to mean revert, the Author cannot think of a worse idea than to filter funds based on historic returns.

6) Don’t keep selling underperforming funds to buy outperforming funds: This is a common behavioral trait that makes investors feel good at the time of doing it, but compounds into a detrimental tax.

7) Don’t buy thematic funds based on strong back-tests: If a fund is being launched based on an in-vogue theme with a stellar back-test the chances are investors are already too late.

8) Don’t invest in active managers if one cannot bear long spells of poor performance: Even skillful active managers will underperform for long periods, if that is unappealing, invest in index funds.

9) Don’t invest in funds if one does not understand how they make money: Investing in things investors don’t understand is a recipe for disaster.

10) Don’t persist with active managers when they start doing something different: The circle of competence for active managers is usually incredibly narrow, if they are venturing outside of that, investors should avoid them.

Source: www. behaviouralinvestment.com by Joe Wiggins

Asset Multiplier Comments:

Each of these prohibitions attempts to establish a simple investing process that can be effective during highly uncertain environments which especially creates a lot of unnecessary noise.
Putting a stop to hasty decisions is as important as embracing positive investing actions. These will ensure that investors’ capital is protected and the process of wealth creation does not get hampered.

By Rutuja Chavan Investment articles wealth creation 0 Comments Read more...

13 Apr

Loss Aversion…

It is a human tendency to avoid a loss as much as possible. A loss of Rs. 1000 gives much more pain than the amount of joy derived after gaining Rs.1000. Humans have a bias against loss and this has been proved in many behavioral studies. Loss aversion must be inbuilt in humans as in ancient times, being careless in hunting or an injury or getting excluded from the group could lead a human to die as the world was harsh. Therefore people who were cautious survived and investors today are their descendants. So evolution has made them such that they fear loss more than they like to gain.

Few day-to-day examples – People are hesitant to sell a favorite old car or a piano even if it is not of much use to them now. If they are forced to sell it, they ask for a high price as they feel they are giving away something valuable and cannot bear to see it go.

Doesn’t everyone get tempted by offers such as ‘Buy 2, Get 1 Free’ even though they might not need three! People want to take up the offer as they do not want to lose the one that is given free. Everyone is apprehensive about taking up a new role in the company that they work in or changing a job as they are in a comfortable place and do not want to risk it. Caution is good but being so cautious that investors don’t take up any risks or challenges will not help them achieve their goals or ambitions.

How does Loss Aversion affect personal finance?

Many investors do not sell loss-making investments hoping against hope that someday they might be profitable. This delay leads to further loss due to the erosion of the capital value.
On the other hand, investors tend to sell off stocks whose prices are rising. investors feel that if they do not sell them, prices might fall and they will end up making losses.
Many investors stay away from falling markets as they cannot digest losses. When the markets come back to their true valuations, high-quality stocks & Mutual Funds would bounce back. People would have lost the chance to buy attractive stocks at low prices.
People invest maximum amount in safe, low-interest investment products that provide no great returns nor are able to beat inflation.

Source: www.tflguide.com by Hemant Beniwal

Asset Multiplier Comments:

Holding on to loss-making investments hoping that they will turn around or averaging an investment with shaky fundamentals is a definitive way that results in capital erosion.
Even the most seasoned investors demonstrate loss-averse behavior, the only way to avoid the trap is to cut our losses as early as possible and ensure our capital is preserved.

By Assetmultiplier Investment articles investments, losses 0 Comments Read more...