Sunday, February 1, 2015

INVESTOR OVER CONFIDENCE PITFALLS....LEADS TO SLEEPLESS NIGHTS

The Indian equity markets are currently in the all time high zone and are aggressively discounting every bad news across any part of the economy. Investors are also very confident regarding the investments in these market conditions. I am not going to discuss about the market outlook and the next level of Nifty. I am going to discuss the second part of the story of Investors Behavior and its mistakes in investments. The time has come when investor friends would be either friends or would become enemies .Well surprised to read the same that how friends in investments becomes enemies. Well that is what is called behavioral finance and that’s what I will discuss today.  The time is back when we are entering into the phenomena of sleepless nights and I will be discussing about few of the pitfalls we are committing.

It’s being found that we all lack investment objectives and we are all running at the back of herd for beating the market. We lack investments goals and we are more focused towards following others in investments. We feel pride and status while doing investments without accessing risk levels as we take the same as being part of herd community of investors. We follow it as practice status rather than the hard core realty of investments. Be confident but not over confident since over confidence makes us blind. We have found that when the markets are creating new heights the societies of investors are divided into two segments 1) Over confidence and 2) Cautious outlook. The 2nd class of investors are often criticized that they lose opportunities being cautious. Well loosing and opportunity is much better than losing the hard earned money of the investors. Over confidence is more driven by the fear of not acknowledging that loss in evident and more of making profit. The game of finding investments with profits higher than risks is tempting, even when we know that it is difficult to win. Yes this game of winning and the boost of steroids injected by the brokers and community of investors become the blind cover to realize the current position of investments.

Overconfident investors overestimate their ability to evaluate a company as a potential investment. Overconfident investors overestimate the probability that their personal assessments of a security’s value are more accurate than the assessments offered by others. But I can’t impose the whole of the blame on them alone. The brokers, dealers and friend circle are all involved in the same game.Overconfident investors, especially those who are prone to prediction overconfidence, tend to underestimate downside risks. They are so confident in their predictions that they do not fully consider the likelihood of incurring losses in their portfolios.

Before investments we discuss of asset allocation, risk taking capacities etc. Once the bulls get into the nerves of our blood we forget all these basics and we join the herd of uneducated players who bet on their luck for making returns for investments. We pledge more and more to save the and not to acknowledge the losses and we keep on betting. Tell me one thing, did you ever find any broker, dealer or advisor advising you to maintain your asset allocation and risk profile level when the markets are in the top level.

 No we don’t find any one advising use, rather we find brokers, dealers, friends, herd of investors community busy in injecting more steroids of doing investments. Further brokers, dealers and advisors fear that if they ask the client to reduce their position and liquidate and stay in the sidelines they might lose the money from coming back to them.  They fear that if money gets out of equity asset class the investor might park the same in some other asset class .Hence low level of knowledge is being shared with them during these times and more investment focus driven stories are floated in the market.We discount risk, leverage and efficient advisory.

When we suffer a loss we are immediately asked to invest more and recoup the same with average out. This average out story continues until we die completely. In fact when we were bought up by our parents we were told to cut down on losses but never told to cut down on profits. But when the vibration of the market comes we forget both. The reason behind we can’t accept losses and we can’t take of loss among the community of investors or herd of investors. The smile of discussing winning stories with a raised collar stops us form booking profits and also loses. We don’t book profit as others are not doing the same-means if others are donkeys I also become one of them as I part of the community of them.

Often its being found that mental accounting of profit and loss bearing becomes a killer in these type of situations. We do not need to acknowledge our loss fully because it is only a paper loss. We do not realize the loss yet by selling the stock. The mental account containing the stock is still open, keeping alive the hope that losses will turn into gains. Hence we keep wearing the jacket of overconfidence despite of loses. We think and dream that bull rally of the market will recover the losess. We start searching similar peoples and stories where we match our mind set in these situations. In short we search for overconfidence and the brokers, dealers and financial players inject the same equally among the investors.

Well another part of the story is that when tow investor friend become jealous of each other. This happens when one investor books profits and is happy with 5% return on his investments depending upon his own satisfaction level where as the other one stays invested and either ends up with -5% return or 10% gain.  The difference here is that level of expectation and the control over the greed by calculating the risk being taken by the investor. Control over the greed and following the basics at any level is the key to success in investments. One gets saved from the overconfidence and also from the grips of pride and failure to accept the losess.

We seek for TIPs in investments which is nothing but the greed to beat the one another. This beat the market kills our thought process and the same is being exploited by the financial players in the market. Overconfident investors decrease their expected utilities by trading too much; they hold unrealistic beliefs about how high their returns will be and how precisely these returns can be estimated; and, they expend too many resources obtaining investment information.

Conclusion:

Underestimating downside risk, trading too frequently and/or trading in pursuit of the “next hot stock,” and holding an under diversified portfolio all pose serious threat to the investments. Follow the basics and follow asset allocation strategy. Book profits but also book loses so that loses don’t extend further. Don’t be over confident and don’t be greedy. Avoid herds and avoid seeking tips and information which is detrimental to your investment objectives. Be confident but not over confident. Don’t add investments into your status quo since that become more painful as you are unable to exit loses. Learn the pitfalls before you invest since that saves you from having sleepless nights.


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