Mental Biases

Good Morning!

Have you ever heard of biases in your everyday life? Be it biases in your own way of delivering decisions towards solving a problem or biases in executing an act that warrants for an action, have you ever paused and wonder if the results had been done based on careful thoughts stemmed from gathered historical data stored in your mind bank? If your answer is undoubtedly YES!, then why the end consequences can be incorrect at sometimes if not at all times? Why actions and our decisions can be proven wrong regularly? Why solutions to a problem can never be sought by you even after trying for a numerous time?

The answer lies in the human mind itself. We humans tend to formulate a set of data embedded in our mind; which is gathered tirelessly throughout life's development. In the investment environment, this sets of data determines our investment behavior. Investor's pattern of investing behavior to a larger extent influences the anticipated return of total investment portfolio that is designed to meet the financial objective. To put it in a simple language, your investment rate of return is tied to your behavior!

Our investment behavior is can be described as a compounded sets of biases and non-biases, and it magnifies as you take part in own's personal growth.

Some of the biases are, "Representative biases", "Anchoring biases", Availability biases", "Loss Aversion" and "Mental accounting".

It is believed that all biases are products of thinking irrationally.

Let me share with you a real life story of how biases can influence investment.

I approached a client of mine sometime in November 2013. The client wanted to invest RM 100000 in Unit trust investment scheme and asked me to choose funds according to his investment objective. This was what i recommended to him.

Invest RM 50000 in an equity type capital growth category fund. The fund's financial year end was December 30, 2013 and therefore most likely if a distribution is announced, to reinvest all dividend proceeds back into the same fund to capitalize on the units. In addition, i advised him to further invest the balance RM 50000 into the same fund after the distribution date which was around the first week of January 2014.

I educated him that since the distribution comes from the NAV of total fund, the post-distribution fund price will drop. And when it drops, it is a right time to accumulate more units, thus bringing down the cost per unit of the fund. This strategic move was well accepted by him in November 2013. He went on to invest as planned.

However, in January 2014 he changed his mind. Although the NAV price post-distribution became much lower than his holding cost per unit, he insisted to further hold on to the topping up. He did not further invest the balance RM 50000 to the existing initial RM 50000 that already been invested. His reason was that the NAV will further head downside and he believe that after the coming Chinese New Year festival, the price will further drop. His irrational behavior was supported by his previous convicted experiences. He anticipated that usually prices will fall after the chinese new year. Although his irrational behavior was predictable, i am pretty sure that he had made a decision based on past historical data, and this type of bias is known as the "Anchoring Biases".

Personally, my observation is opposite to his. His procrastination attitude will definitely cause him to lose the opportunity prevailing at current. 

What did i do then, to convince him? Well, i did exactly nothing. Since he was so adamantly anchored to his anticipation, i let him to have his own way. Hey! isn't customer is always right?"

So, as a conclusion, given a scenario as above, i advise investors to carefully judge and derive to conclusions based on strategy and avoid biases. Think rationally!

Penning off for now, happy investing!