Nikhil Walavalkar, ET Bureau
A teacher once asked a student, “If there are 10 sheep in a field and one escapes through a hole in the fence, how many are left?” Student answers, “None.” When the teacher berated the student for his poor maths, the student replied, “I know my maths, but you do not know about sheep.”
Some investors find it difficult to invest gainfully in equities because of behavioural issues. Here are some of the factors that investors should be careful about while investing in equities.
Herd mentality
Herd mentality means the sheep-like tendency to mimic others. “ Herd mentality can adversely impact an individual. When there is a scarcity of resources, it can be fatal,” says Om Ahuja, head – wealth management & strategy, Emkay Global Financial Services.
Most of the time, it leads to bad investment decisions as an individual ends up buying something unsuitable for his needs. Buying into small and micro-cap companies just because they have rallied on the bourses is a classic example of herd mentality. In most cases, followers fail to notice a change in the trend and incur losses. Unfortunately, blind followers return when they spot a herd to follow.
One can look at this from another angle. People tend to purchase a financial product when they get a call from a distributor who also tells that your best friend or neighbour has also bought it.
Anchoring
We tend to value our assets using certain reference points which may have no relevance to the present market condition. For instance, many assume that when a stock hits a 52-week high, it is time to book profits. Since listing, HDFC has hit 52-week highs several times.
Had you sold because the stock has hit a 52-week high, you would have lost heavily on opportunity. “The price point that an investor gets anchored to is the cost price, and if the stock goes down and the investor does not book loss, he aggravates his loss,” says Jayant Pai, vice-president, Parag Parikh Financial Advisory Services.
A similar example of anchoring can be seen in other day-to-day decisions like sales. Buyers may travel an hour to throng a sale offering 50% discount, even if the value of the purchase is a few hundred rupees, but he may ignore a 0.5% discount on something that costs tens of thousands of rupees.
Overweighing what can be counted
Albert Einstein got it right when he remarked, “Not everything that counts can be counted and not everything that can be counted, counts.” Many a time investors come across a stock that seems to be ignored by market forces. Such stocks represent a business with sustained rise in profits, return ratios higher than industry norms and a fantastic looking business model. For years the market has not given the stock its due and it quotes at bizarre valuations.
In heady markets such as the one we are living in, such hidden gems come forth and naive investors fall for them. Barring stray instances, they land on the wrong side. The reasons remain in the not measurable segment of analysis.
Endowment effect
It is the ‘endowment effect’ that blindfolds many investors when the stocks they hold start their downward journey. Individuals believe that the things they own are worth more than their real worth. Investors are no different. The stocks owned by them are seen to be more valuable than their actual worth. Investors find reasons to substantiate why they bought a stock and why they were holding on to a particular stock.
Theme junkies
To a man with a hammer, everything looks like a nail. When investors have only one idea, it can be a very dangerous situation. Especially, if the idea is a borrowed one, it can be fatal. When investors hear themes such as ‘India consumption’, there is a tendency to go for it and scenario starts worsening when investors try to look at ‘consumption’ in each and every stock they come across. Instead of being objective, investors try to rationalise and incur losses in the long term.
Incentive-caused bias
“Never ask a barber whether you need a haircut,” goes the old saying. Some lawyers induce clients to litigate when it is in the clients’ interest to settle and some doctors prescribe high-cost treatment when they could have treated the patients with a cheaper solution. These are classic instances of incentive-caused bias. In financial markets, we come across many such barbers – read intermediaries with vested interests. Sell-side analysts – analysts who recommend stocks to others – are a classic case in point. Typically, a sell-side analyst has more of ‘buy’ recommendations than ‘sell’ recommendations. They are to be watched out more carefully in boom phases.
On the other hand, there are some distributors offering investors products that offer the distributors higher fees or commissions and are not in the best interest of the investors.
http://economictimes.indiatimes.com/quickiearticleshow/6317492.cms
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