Your long-term investment success is determined by your ability to control your ‘inner demons’ and ‘psychological traps’. The good news is that human behaviour is irrational in a predictive manner, as examined by Professor Dan Ariely in his book ‘Predictably Irrational’. Once we recognise these ‘inner demons’, we can develop approaches to tackle them. A thoughtful investor can leverage this predictable irrationality by remaining un-swayed by the noise and making rational decisions, thereby taking advantage of others’ ‘behavioural biases’.
One of the inner demon is ‘overconfidence’. Time and again we tend to overrate our ability, knowledge and skill. Watching 24-hours news channels and listening to ‘experts’ we tend to believe that we are experts and make investment decisions that are not thought through. We think we can predict and time every up and down of daily price movements and invest accordingly.
Over confidence can lead to excessive trading and poor investment decisions. To be a successful investor, one needs to follow a zero-based approach towards decision-making. Investors need to be prudent to not sell their winners too soon and nor hold on to their losers too long.
Another important psychological trap we need to avoid is ‘herding’. People tend to follow actions of a larger group, independent of their own knowledge. Large-scale social imitation can lead to significant gaps between actual value and price. This herd-like behaviour phenomena can create profitable opportunities for individual stock. But taking advantages of collective irrationality, either for a specific stock or for the market as a whole, is difficult. Since most of us have a strong urge to be part of the crowd, acting independently is not an easy feat.
However, if we’re able to control this behaviour, it can result in significant investment gain for us. Warren Buffet sums this up by saying: “We simply attempt to be fearful when others are greedy and to be greedy only when other are fearful”. It requires significant control over one’s emotions to practice in real life.
Focus on avoiding silly behavioural mistakes
Research has shown that behavioural mistakes can reduce the return on investments by 10% to 75%. So what do you need to do avoid this? It can be summarised in one word: discipline. One need not always focus on becoming smart. Avoiding silly behavioural mistakes can help one become a successful investor in the long-term.
Key takeaway
(The writer is Managing Director at Kotak Mutual Fund)