Cause & Effect. Common biases that influence investors

In the last decade, the Sensex gave an annualised return of 11 per cent compared with 8-8.5 per cent return by banks’ fixed deposits. Yet the equity investment penetration in the country is abysmally low.

The reasons why investors prefer not to park their money in stocks are many and can be classified as various behavioural biases. We spoke to a few people with a household income of ₹1 lakh per month or more, and who do not hold stocks, to understand why they act that way.

 Here are some reactions we got from the conversations.

Eswar, a commerce graduate with 15 years of work experience, has not invested in equity simply because he hasn’t found an apt guide. He is also not clear about how a mutual fund differs from an equity. He is more comfortable parking his money in a chit fund run by a businessman that earns him 10-15 per cent return a year. His colleagues too have invested in the same chit fund and have almost nil exposure to the stock market. This behaviour indicates a confirmation bias. Under this, people tend to act only on information that conforms to their original view and reject all other opinions. 

Few years ago, Eswar suffered an 18 per cent loss on the original principal when he invested in a mutual fund. This added a fear quotient and increased his aversion to the stock market, indicating strong loss-aversion bias (inability to accept losses) and regret-aversion bias (inaction due to fear of taking the wrong decision).  

Arun, an engineer, is keeping away from equities because he feels he does not know enough about it. He claims that no one has ever advised him about investing in various schemes and the stock market in general.

This is interesting, given that his father is an insurance agent and has investments in mutual funds. He has been servicing a housing loan since 2008. He confesses that he could not save any money from his salary till the end of 2011 after which he managed a monthly savings. He wants to invest in stocks if he gets a trustworthy investment advisor, who is also a good friend or colleague.

This indicates a regret aversion bias. He has not approached any financial institutions for investment advice. Since Arun’s father is an investor and insurance agent, the fact that he stayed away from equity could be due to status quo bias (wherein a person maintains a position because of inertia rather than conscious choice).

Vinod thinks two to three hours of research in various schemes and stocks is a prerequisite for investing in the stock market. This has stopped him from taking the first step to investing in equities. He has also generally shied away when his colleagues discussed their investment strategies. This shows a strong confirmation bias. He confesses that he showed no interest when approached by mutual fund advisors or when his wife brought mutual fund brochures home. He cites lack of time to justify his current stance, thus indicating a strong status quo bias.

Both Vinod and his wife have multiple long-term life insurance for ₹50 lakh each and a child’s education insurance plan. One of the life insurance schemes has money back guarantee providing additional liquidity every five years. He also has a monthly fixed deposit savings and buffer amount allocation equivalent to 18 per cent and 10 per cent respectively.

Vinod is adopting an approach wherein he is setting aside separate investments for a particular goal. His financial planning is on the right lines.

If he starts moving some money into equity as well, it will make it easier for him to achieve his financial goals.