Behavioural Finance – Make Smarter Financial Decisions

by Hemant Beniwal on August 3, 2012

There are 3 stages to master any sport. It starts with training, practice & then comes the match or the tournament.

Trainings are always boring compared to matches. Training is boring because it involves learning basics which are quite dull but we all know that it’s an important part. But do we really give time to learn them? Md. Ali said “I train so that I can dance well in boxing ring.” Let’s talk about investment you make… all of us run to earn money but do you give time to learn about it, before taking a decision. Think!!

Second stage is practice. When you play with friends or colleagues without any pressure of losing, you play really well – nice shots sometimes and you even feel that you are in a wrong profession as you were made to be a sportsperson!

behavioural finance Behavioural Finance  – Make Smarter Financial DecisionsFinally, when you enter a tournament, you suddenly notice that you are not getting a single shot  right – you wonder where those skills have vanished for which your friends cheered during the practice sessions? You were so good at nets because there was no pressure, but now there is a pressure of winning and you know – everyone is watching you. Losing a point means a lot now. You become lot more cautious with your strokes and it shows.

Can we compare it with investment scene? You start with learning basics of investing, then you make strategies sitting outside the markets & finally you dare to invest some real money. In investments 90% of people actually get their learning lessons during matches – they think they can learn the things while playing the tournament directly. Definitely yes, but still basics are required and essential. “It’s always good to learn from other’s experience – it’s cheap”. Read: WHY do we make financial mistakes.

What is Behavioral Finance ?

Behavioral finance combines understanding of behavioral & psychological with financial decision making process. Financial planning involves a very essential element which is called decision making. We come across people who are either over-confident about their ability to decide or they lack that courage to admit that they make bad decisions too. It is the personality which is responsible for this state of mind. In fact, we all have seen a bit of life, its ups & downs, happiness & grief, which leaves scratches over our sub-conscious. So, next time when we have to make a decision in life these sub conscious events surface and becomes the behavior about that situation.

Behavioral Finance – Classifying Investor

By observation we have seen this financial behavior of investors can be broadly classified in 4 segments.  There can be other classification as well, but these behavior aspects try to cover all types of investors.

Prospect thinkers: Here the investor is always thinking about the consequences. He overlooks the present returns and is more concerned of future returns. He assumes uncertainty and risk and forgets the merit of an investment decision. Suppose you tell such an investor that the product has 20 % chances of losing money but 80% chances to give you 12% returns- he will assume the product to be very risky and would ask for a product with 100% capital protection or worse he would not invest at all. A prospective investor would even suspect the people, who make them aware of the risk involved.

Regret avoiders: These investors do not wish to regret, so they do not take a decision. They would not sell a stock, even if they have achieved their desired result. They often find it easier to follow a group when it comes to buying or selling a favorite stock. They tend to defer selling a stock which has gone down or buying a stock which has gone up without any major changes in fundamentals. Hope you remember ICICI bank came down from 1450 to 250 – who lost money??

Recent followers: These investors are carried away by present scenarios. They think the price at which they are getting is right. Too much time and efforts are given to the recent figures, analysis, trends and the historical and fundamental facts are ignored. Normally, this also happens when investor is new to a particular product and does not have access to the past information.

Over & Under Reactors: Here the investor either is over confident or under self-evaluation. An overconfident investor exaggerates his talent and forgets other factors which he cannot control. The irony is more confident a person, more the chance that he would be overconfident as well. Few people are pessimists too. They try to avoid decisions and even to the extent of not meeting the people who can assist them to make good financial decisions.

And due to these traits we see following mistakes happening:

  1. Foreseeing losses, which may not happen
  2. You believe that to be successful in investing you need to have big time knowledge.
  3. You tend to invest without knowing the horizon of investment.
  4. You only try to see or read the information which confirms your action. Counter views are ignored.
  5. You do not think that small and timely decisions now will help you achieve your goals comfortably.

How to know that your are improving your financial behavior

Behavior finance is not too hard to learn. Start by becoming humble. Make sure you avoid the costly leveraging and your portfolio is diversified. Minimize short term bets and trading. Be patient and don’t aim to get rich in a minute. Follow stocks and not the price. Do not just keep watching and noting the price of an investment. Also develop a system which filters information regarding your system. Try minimizing the noise. Do not talk about your investments to every one in the town. Instead if you are not sure of your decisions get a trusted partner who has expertise in that area. Admit and learn from mistakes – but learn the right lessons and don’t get obsessed about initial success. Also sell your mistakes and move on but be careful about not panicking and selling at the bottom.

Remember investment is about a worry free life. You will not get another life to enjoy. So it is better to make best out it by correcting our behavior towards investments.

Download & read the full Behavioral Finance Guide from here

– this will change your response to the investment world.

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{ 4 comments… read them below or add one }

1 ANIL KUMAR KAPILA

Hi Hemant
Very useful article.However, I was not able to download and read the guide.

Reply

2 manish

hey overall the article was gud but not able to download this guide

Reply

3 madhuk

Hi Hemant,
i m a B.tech graduate from reputed institute. m working for a PSU( Govt company) as a assistant executive engineer. my annual salary is around 6.25lakhs(Next year it will become 7.25 lakhs). my age is 25. i am very much interested in CFP. i would like to change my profession. is it possible? and can i earn more than what am earning now?.. please guide me in detail..
Thanx…

Reply

4 ANIL KUMAR KAPILA

I don’t see any reason why you want to change your profession. You are not doing bad. Stick to your present job.

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