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Psychological Biases - 1
As individuals, we like to take rational decisions to support our living. But, if we intend to
make sound decisions, then, why many of our judgments prove out to be wrong? Well!
The answer is that human beings are emotional beings! Our emotions impact us so much
that at times our inherent behavioural biases come in our way of making rational
decisions.

We all tend to keep scanning and absorbing the information that is presented to us by the
environment around. And, we have been designed to draw conclusions or interpretations
from all that we see and hear around.

Thus, what differentiates an average investor from an experienced investor is that the
latter approaches investing with the right psychology which is free from mental biases to
a great extent.

Just like physical ailments affect the ability to work properly, Mental Biases affect mind's
ability to process information correctly.

So, let us see a few big emotional biases that we come across at all times.

1. Familiarity bias towards known brands/names

Familiarity biases are indeed the most common biases that are seen in everyday life.

Symptoms

1. The investors tend to overweight the stocks of the companies they already
know, already use or are familiar with. For example, if an investor is using iphone, he/she
will prefer investing in Apple.

2. Though, the theories of investment insist that one needs to invest in stocks
after thorough research and analysis, yet, the investors are attracted towards familiar
securities due to the comfort they gain in investing in a known zone.

3. Investors are so highly biased towards stocks of the companies they are familiar with,
that they prefer to invest in their own companies despite knowing that there are many
other good investment opportunities available.

Common Occurrence

This bias is commonly seen in individuals who love to live within their comfort zones. Such
individuals fear to travel the unthreaded path as unfamiliarity makes them uneasy.

Potential Harms
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If an investor is investing in the same company in which he is working, they don't realize
that, they are doubly risking their money. As, in case, the company does not perform well;
then, the employee may suffer reduced salary income and reduced returns on the
investments.

Prevention

While investing in your own company you must do a thorough analysis, such as consider
the anticipated returns, analyse the industry performance, transaction costs, etc. But,
sometimes the familiarity bias drives the investors so firmly that they blindly invest in the
companies in which they have been working for a few years.

2. Representativeness

Representativeness is a widespread bias that is governed by the image, representation

or past performance of a company.

Symptoms

1. If investor considers a company to be a good company, then, he tends to

instantly choose to invest in it thinking that it has good investment value.
2. Investors often take the past performance of stocks as representative of their
future performance. For example - Videocon is a renowned brand, but investing
in shares by relying solely on brand name rather than fundamentals of the
company can burn a hole in the pockets of investors.
3. They try to forecast performance of the stock in future, based on its similarities
with its peers.

Common occurrence

When the availability of specific information like extended news coverage of highly
performing stock spreads like a fire, it grabs the attention of potential investors
immediately. Such news stimulates trading of shares due to the development of
immediate biases towards them.

Potential harms

This can be misleading as its brand image cannot judge the exact worth of a company.
The image of a company can be enhanced due to advertising and promotional activities.

Prevention

Investors should not be swayed away by the brand name or window dressing by the
companies; rather they should focus on the fundamentals and future aspects.

3. Anchoring
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Anchoring refers to using irrelevant information as a base to make financial investments.

Symptoms

Investors tend to get fixed on the past information to make current investment decisions

For example - Suppose, you want to buy a property and get an initial quote of INR
10,00,000 for a flat. Now, this works as a reference point for you. After a few months pass
by, the market crashes and the prices of the property go down. Hence, now suppose your
dealer quotes you 9,00,000 Rs. for the same property, you might like it without being
aware that the current price is Rs. 8,00,000. This happens because you got anchored to
the initial price quote of 10,00,000 and so anything lesser than that would mean a good
deal to you.

Occurrence

Anchoring bias is commonly seen in both naïve as well as professional investors.

However, professional investors have more access and exposure in investments to gauge
themselves if they are letting these biases influence them.

Potential harms

If an investor has seen a stock priced at Rs. 1 OO and found it overpriced, the moment it
touches Rs. 80, he would jump over to grab it. But, had he not been anchored to the initial
hiked price of Rs. 1 OO, then, he would have waited further to see if the prices would steep
down further. Later, he gets to know that the prices dropped down to Rs. 65 just a week
later. Now, do you think that holding on to the initial pricing was wise?

Or similarly, if a stock was trading at Rs 1 OO, and is now trading at Rs 150, it does not
always mean that the stock is trading expensive, it may be possible that company's
valuation has improved in the mean time.

4. Overconfidence Bias

Overconfidence refers to an investor having a bias towards his prediction skills, his
judgments about the market behaviour and his cognitive abilities.

Symptoms

1. ln these biases, the investor tends to over evaluate not just his prediction skills but
also the information that he has received.
2. The investor considers himself to be smarter than other investors and advisors.

Potential Harms
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a. Excessive Trading: Overconfidence often results in excessive trading. Since the

investors are over-confident about their knowledge it makes them trade often.

b. Under-diversification: The over-confident investor tends to opt for a concentrated

portfolio because he is super confident about his investments and puts in all his money
in chosen stocks. This results in under-diversification which is also a trait of seasoned
investor but the approach taken by them is way too different as compared to over­
confident investors.

c. Excessively optimistic: Over-confident investors are highly optimistic about the

companies they track. They are not open to the possibility that their assumptions can be
miscalculated or be overrated as compared to reality.

Common occurrence

Investors convince themselves that they are better than others (maybe due to any correct
predictions made earlier) and start to ignore earlier signs of potential damage.

Prevention

Investors should safeguard themselves from this bias by reading and re-reading super
texts of legends of investing.

5. Herd mentality Bias

Man is a social being. He does not like to cut out from a trend or to opt out from a
movement. And, marketers know this very well. They try to position a product to create a
brand such that people start relating to it and some people keep joining it. So. this
becomes a trend and others blindly follow it to be a part of a social norm.
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Symptoms:

ln this bias, an investor tends to copy other investors. This type of bias is dominated by
an investor's instinct and emotions rather than the analytical approach taken to
understand a stock before investing in it.

Common occurrence

One reason for herd mentality bias is the human tendency to adhere to social pressure
and customs.

lt is mainly caused because investors feel pain on acting against the crowd.

Potentíal Damage

One of the major market crashes in the history was due to the Dot com bubble. Those
companies did not have sound business model but people bought into them as everyone
else was buying them.

Herd mentality also won't let you outperform the market. If you behave the same in the
same way as others, you will earn same as them.

Prevention

Investors should not be reluctant to act contrary to everyone.

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6. Commitment Bias

This biasness refers to the tendency of investors of being stuck to their original beliefs
regardless of the dynamic market conditions.

Symptoms:

Investors tend to develop an attachment to their past ideas and beliefs so much so, that
they keep applying them in new situations even when they seem to be irrational.

Common occurrence

Commitment bias is usually seen in our day to day lives when we do things or take
decisions only to approve or justify our past actions. lt is like one slippery slope where a
single slip is enough to pull you down completely.

Potential Harms

ln the field of finance, commitment bias can make an investor hold on to a security longer
just because he chose to invest in it, even when it is contrary to the interest of the investor.

Prevention

Investors can reduce the risk of commitment bias by continuously being aware of the
changes in the market and his tendencies and should seek out contrary information on a
routine basis.

Investors should always be able to admit errors to make intelligent investment decisions.
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Psychological Biases - 2
Do Something Bias

lt is a tendency of investors to act. lt can also be said to be the lack of ability of investors
to sit idle.

lt can also be said to be tendency to act on every happening rather than sitting back and
waiting for the right time to act.

Human beings are tuned for actions. Lets us understand this with the help of a story. After
death, a man landed in heaven. He was provided with all sorts of facilities and luxuries.
He had to do nothing and had servants appointed for every petty job.

After few weeks, he started disliking this experience. Since, he had nothing to do, after
being frustrated and bored, he asked god, what kind of a heaven is this?

The reply was-" who told you it is heaven?"

Symptoms

1. ln an attempt to be more productive and efficient people tend to keep themselves busy
with one thing or the other, even though it is wasteful.

2. Investors tend to react(buy and sell) to each and every news about the company,
market or the economy.

3. Investors faces lack of patience and anxiety and thus is not able to take right decisions.

4. Investors tend to make unnecessary decisions when "nothing is required".

Common occurrence

One of the reason for occurrence of this bias is over load of information. Investors not
only want to be updated about each and every factor revolving around the companies but
they also act on each of such information.

lt is also commonly seen when investor's portfolio is not performing well, so it gets very
difficult for him to sit idle and wait for the market to recover.

Precautions

1. Investors should ignore short term fluctuations in the stock price. If investor react to
each and every noise and churn the portfolio accordingly, overall performance would be
poor.
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2. ln case of a bearish market, investors should try to be patient giving time to recover
rather than making hasty decisions.

3. If investor cannot find any nice investment opportunity (during the bull market), it is
again suggested to have patience rather than betting and losing the hard earned money.

Potential harms

1. Lower returns due to a lot of churning.

2. Higher transaction costs

3. Investors suffers avoidable losses.

4. Taking a lot of decisions also causes decision fatigue, where making too many decision
lowers the quality of the decisions, increasing the odds of failure.

Status Quo Bias

lt is just opposite of "Do something Bias", where people don't do anything and continue
to maintain their current status. lt is like living your life in an "autopilot" mode.

For example- Amazon prime automatically renews the subscription at the end of period,
and most peoples are stuck with it as they forget to opt out of the cycle. But if they are
asked to renew it every month, people would analyse their decisions every time and are
more likely to opt out.

Symptoms

1. Investors remain so happy with their existing status (however miserable) that they
refuse to act to change it.

2. Investors tend to stay invested in stocks, even though they are not able to create
sufficient value.

Occurence

One of the reason for this kind of bias is human tendency to procrastinate ( leave the work
for a future date).

Another reason for this bias is that people are scared that their action may in turn ruin the
existing (which is now their comfort zone) situation for them.

Precaution
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1. Investors can use the status quo as a benefit by starting a monthly SIP. Once started,
you wont be willing to take the pain to change it.

2. Investors should periodically revisit and analyse their portfolio and act accordingly.

Potential damage

Investors may miss the opportunities available around them, by simply ignoring them.

Confirmation Bias

Confirmation bias indicates the tendency to use or interpret a piece of information to

support your perceived notions and ignore the ones that are contrary to your beliefs.

What
Objective Confirms
Facts Your
Beliefs

What you see

Symptoms

1. If an investor is interested in investing in any company say 'Airtel,' then, he would look
for positive information that would support his decision of investing in Airtel. Hence, if
such an investor will come across any negative piece of information or clues about the
company, then, he or she may tend to overlook it.

2. Investors tend to ignore useful facts and information which do not comply with their
preconceived notion.

3. Investors are just able to see one sided view of the company.

Potential damage

1. Confirmatíon bias causes investors to make poor and biased decisions.

2. This bias is result of the overconfidence of investors explains why market behaves in
an irrational way.
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3. Bulls tend to remain bullish and bears tend to remain bearish, regardless of the market
conditions.

Precautions

A good investment strategy is always to look for information that contradicts your way of
thinking. This is what most successful investors have been doing. The point to note is that
you need to approach investments with an open mind as the shreds of evidence collected
tends to flow in all different directions. Consequently, you would analyse the multiple
perspectives which will overcome any influences or biases present.

Hindsight Bias

lt is biased in which a person believes that the previous event/s were predictable and
obvious. Such biases happen now and then in our daily lives.

Symptoms

This bias forces the investor to find a wrong link between the cause and effect of
investment. lt will hence oversimplify the situation which might land up an investor into
troubles later.

After one or two instances, investors tend to be over confident about their predictability if
the stock market.

Occurence

Hindsight biases occur due to this innate desire to bring order in lives. People tend to look
for simpler solutions to all complicated problems and thus tend to overthink and develop
such biases.

During the Great Recession of 2008, many so-called analysts tried to demonstrate events
that made the depression look very obvious. If it was that obvious to the general
population it would have been avoided it in the first place itself.

So, let us take an example of an investor Mr. X. He traced every drop in prices of the
share to a particular happening. This should be noted that, he would trace it back after
the price has already fallen. Eventually, Mr. X becomes highly over confident about
himself and his ability to predict the market correctly.

The important thing is that at the time of happening of event, it is highly improbable that
it will lead to a drop in prices of share.

Precautions
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Investors should be careful about the factors that are affecting their decision making while
analysing the companies. Their personal opinion should not be the only factor responsible
for the decision making.

Investors should consider analysing the intrinsic value of the company as it is based on
quantitative factors rather than personal ones.

Potential harms

Hindsight bias drives away the investor from doing an objective analysis of the company.

Further, investment decisions made in overconfidence seldom proves fruitful to the

investors.

Dealing with the Biases

The psychological biases are capable of taking a toll on investors's financial health. lt is
thus important to be aware of your situation and recognise the biases on a timely basis
and go through the following templates-

1. Look at the Big picture: The investment market is highly inter-linked both at domestic
as well as at global levels. When you look at every single investment that you have made,
then, you have considerably narrowed your perspective of understanding how the market
works. But, when you tend to understand the happenings at national and international
level meaning closely watching the developments happening, the growing industries and
the players, the future demands and growth perspectives of the market as a whole, then,
you get to see the much broader and realistic view of the market.

2. Investments are bound to fluctuate especially in the shorter run, but when you learn to
analyse the investment scenario in the right manner, then such fluctuations do not matter
to you anymore. And, your wits. your skills, your alertness, and your broader view takes
you closer to generating wealth at the level desired by you.

3. Rely less on what you see: Avoid making a judgment by looking at the generated
reports or trends shown prominently on all news channels. Instead, you must try to
engage yourself more in reading about the industries or companies where you want to
invest or has already spent.

4. Be knowledgeable: The more you strive to learn about stock investments yourself, the
less your decisions are affected by behavioural biases. Knowledge is by far the most
reliable instrument that is going to help you master the game of stock investment. Of
course, you cannot learn every aspect of it, but reading can add a lot to your knowledge
and skills.

5. Follow a good mentor: If you are entirely new to investment and know not a thing about
it, then, it would be wise to follow an investment guru like Warren Buffet and Charlie
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Munger. lt will help you to overcome a lot of apprehensions and the popular
misinterpretations of stock market investments.

6. Look at stock investment as a business owner: As we have discussed earlier too, every
investment you make in the stock market must be looked at from the owner's perspective.
And, you need to consider yourself as an owner of the company and then analyse what
would you get out the investment made in the company.

7. Review your biases periodically: You need to review your preferences periodically with
the investments that you were tempted to make or made under the influence of those
biases.