If you are a typical individual, you will have investments in land and gold, but not necessarily in equity. This is because you do not perceive land to be risky, and believe gold is less risky, if at all, than equity. The truth is that land and gold are riskier than you think. What drives your risk perception on these assets?

Understanding bias

Our perception of risk is driven by our biases. And two such biases are illusion of control and exposure effect. Suppose you want to buy a lottery ticket and are offered two choices — either the store manager can randomly pick a ticket for you or you can pick your own ticket. Which would you prefer?

You believe that you can increase your chance of winning by selecting a ticket yourself. You may, for instance, pick the fifth ticket from the pile if 5 is your lucky number.

If you believe that picking a ticket yourself will improve your chances of success, you are suffering from illusion of control.

It turns out that this illusion of control can lower your risk perception. But why should you suffer from illusion of control when it comes to investing in land and gold?

Misguided belief

Land and gold are both consumption and investment assets. You can use land to build a house, either for yourself or for your children. It is, therefore, a consumption asset. Or you can sell the land at a higher price and use the proceeds for your consumption needs. It, therefore, becomes an investment asset. Gold is no different. You can consume gold as jewellery, gift it to your children on their wedding or sell it. This choice of either selling or consuming the assets leads you to believe that you have ‘control’ over your investments. And that belief could substantially reduce your risk perception.

Your upbringing adds to this belief. If your childhood and early adulthood were typical, you would have matured in an environment where the obvious investment choices were real estate and gold. This could have created a sense of familiarity. Your brain is calm when it encounters what is familiar and reacts with fear when it faces the unknown. We are all, therefore, biased towards the familiar. Psychologists call this bias, the exposure effect — this bias prompts you to perceive the familiar (gold and real estate) as safer than the unfamiliar (equity).

All of us have to overcome several psychological biases to explore investment choices beyond real estate and gold. Will you?

(The author is the founder of Navera Consulting. Feedback may be sent to >knowledge@thehindu.co.in )

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