Portfolio Ideas. When bias drives investment behaviour

You may have considered hiring an investment adviser for two reasons. One, not only are investment products complex, there are plenty to choose from. It is easier to outsource your investment decision to a professional. And two, your work life may be too demanding to devote time to managing your investments. Yet, you should not hire an investment adviser for either of these reasons!

You should not be overwhelmed by the choice of investment products available. Nor should you be worried about the lack of time in managing your personal finance. That said, an adviser could play a key role in your investment decision-making process. In this article, we discuss how you can strategically use an adviser to help achieve your life goals.

You are likely to suffer from several biases while managing your own money. Biases are errors you make while taking investment decisions. You are prone to making these errors because of two reasons. One, there is delayed feedback on your investment decision.

That is, you will not know if your decision was correct until the end of the time horizon for which you made the investment! And two, you will regret in hindsight if your decision turns wrong. Because regretting is painful, you will most likely take decisions today that will help you moderate or avoid regret in the future; psychologists call this ‘regret aversion’.

One such decision is to invest more in bonds and less in equity. Investing in bonds can help you generate stable returns, but it may not further your cause of achieving your life goals. Why? Post-tax return on bonds is about 5 per cent, whereas post-tax return on equity is about 12 per cent. So, more you invest in bonds, more the capital you require to achieve your life goals. You otherwise risk falling short of accumulating the wealth required to achieve your life goals.

This is where an adviser plays an important role. You should hire an adviser to manage your biases, not your investment portfolio. Why? Portfolio creation process can be simplified. Managing the portfolio thereafter can be made easy through a rule-based rebalancing process. But it takes lot of discipline to follow rules, given your biases! In essence, we want you to hire a financial therapist, not a typical investment adviser!

Think of a financial therapist as someone who will enable you to overcome your fears about money, facilitate dialogues to resolve conflicts, if any, with your spouse on money matters, and moderate your investment biases. You can also have your adviser draw a roadmap for you to manage your core portfolio. This is the portfolio that you have to create to achieve your life goals.

The roadmap must define the amount of money you have to invest each month to achieve the intended life goal, your allocation towards bonds and equity and the products you should buy to create the portfolio. As the process is based on systematic investment plans (SIPs), you do not have to spend much time managing your portfolio. Except when it comes to managing crisis. That is when you need your financial therapist.

Crisis management could arise due to financial crisis or emotional crisis or both. Suppose you are accumulating wealth to meet a life goal in 2025. What if the stock market tanks in 2018? You may be emotionally driven to moving your equity investments to bonds.

Or you may consider selling your investments in haste to meet a family emergency. A financial therapist can help you moderate your emotions during such crisis and enable you to take an optimal decision.

Therefore, hire an adviser who has deep understanding about how psychology drives investment behaviour. Remember this: You need a behavioural investment coach, not a typical investment adviser.

The writer is the founder of Navera Consulting. Send your queries to portfolioideas@thehindu.co.in

COMMENT NOW