This is one of the most common bias identified while investing. The feeling is so strong, sometimes it leads an investor to becoming speculator.
One of my wife’s cousins during stock market rally between 2003-2008 started investing in equities directly. He belonged to a very wealthy family and hence, owning direct equity of several firms was not new to him. In 2004, he decided to actively get involved in managing the portfolio. To begin with, he only started following index and reading media reports for index movement the next day.
We all know media reporting is after the event had taken place. However, the cousin thought he understood index movement. Let me give an in-depth example. Assume on a particular day index fell by 250 points. Next, day media could report the fall was due to selling by foreign institutions. As far as the media is concerned, they have performed their job. The cousin started thinking he now understands the movement.
Suppose, if there is rise in index and next day media reports the rise is due to latest inflation numbers, the cousin feels he is in grip of the movement. We all know movement of index is not due to a single factor. There are multiple factors, including human emotions and herd mentality for the movement in index.
This emotion led to him to feel he understood the movement and started day trading. This all was fine when market kept rising till 2008. Around 2008-09, there was a massive fall. He was exposed and suffered a loss. While loss was big, it didn’t significantly impact the family due to immense wealth. Also, he earlier set aside a corpus. Reason to get into this in-depth is many investors reflect such emotions when the index is rising
Simply by following the media, listening to so called experts, which occur when the index is rising and discussing it’s behaviour with every possible person does not make an individual expert. It will only lead to overconfidence and a cognitive bias.
Being overconfident in a new endeavour may lead to taking excessive risk. However, taking up the new endeavour with appropriate preparations and thorough planning, even if it means taking risk must be encouraged. In the absence of it, no new endeavour will ever be pursued.
While investing, in direct equity, mutual fund schemes, debt-based instruments, etc. spread it across several assets classes and investment vehicles. Secondly, always keep financial goals in forefront. Iff they are likely to occur after 5-7 years, choose equity as an assets class. Vehicle to investing in direct equity are several and in case of confusion, seek proper professional advice. For financial goals which are likely to come up in 2/3 years, debt-based instruments are preferred. For an interim financial goals, go for combination.
Many a time, I have come across individuals who want to dabble in direct equity market. This is more prevalent in rising stock market. Instead of curbing emotions, I allow them to set aside a pre-determined corpus to dwindle. Overconfidence is an emotion we all have in us. Acknowledge the fact and focus on financial goals while investing.
(The writer is a financial planner and author of Yogic Wealth)