Five Investing Biases That May Impact Your Mutual Fund Portfolio

Published On: 13-Oct-2020

It is said, investing is an art and not a science. There are no fixed principles and rules that may fit financial plans for different investors. This is because investing behaviours portrayed by different investors can lead to different outcomes, even with similar market movements. 

This also forms the foundation for the working of stock exchange markets, wherein two people, a buyer and a seller are taking opposite positions for the same stock. One of the investors is selling the stock, while the other investor is buying the stock in anticipation of future appreciation. 

 

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Here are five investing biases that may impact the mutual fund portfolio:

Herd Investing 

When an investor buys a stock, or invests in a mutual fund scheme based on what others are doing, it is referred to as herd investing. The term is derived from sheep herd, wherein each of the sheep follows what others in the group are doing. It assumes that what the majority of investors are doing would indeed be the right thing to do. Thus, such investment is not based on the investors' fundamental analysis but based on broad-based market consensus. 

Confirmatory Bias

It refers to the investing bias wherein the investors seek psychological confirmation of their investing views. While one may hold a specific view regarding specific stocks, mutual fund schemes, and broader markets, he/ she is likely to remain firm to such an opinion. 

As such, one is likely to focus on the news and analysis confirming such an opinion. On the contrary, any news report or analysis rejecting such an opinion may be conveniently ignored by the investor. It is equally possible that one may hold the right opinion, but even such an opinion may need a reformation and reconsideration when the circumstances change. 

Self-Attribution Bias

Investors often tend to look for external confirmation of their analysis. As such, they may prefer investing in specific sectors/ companies based on their research and knowledge. This is because their internal research and experience may provide additional data to support their conviction. 

Additionally, investors may be more confident in investing in such companies/ sectors/ schemes wherein they may understand the macroeconomic events and understand the impact of the changes happening around them. This also explains why the investors tend to stay more inclined to domestic markets, instead of investing across the geographies. Such an investing bias leads to lesser portfolio diversification, since the investments may be concentrated around specific sectors, themes, etc. 

Disposition Bias

This denotes the investors' tendency to book profits on their winning strategies while continuing to hold on to the loss-making stocks. One is more inclined to show realised profits to the social circles, while equally inclined to hide the stock selections that went wrong and resulted in a loss. This is because they may not want to admit that they made the wrong investment decisions in the first place. 

Additionally, once made, an investment is often seen as a sunk cost, and the profits are booked only if the investment is yielding profits. This results in booking profits earlier while holding on to the loss-making schemes for an extended period. 

Emotional Investing Bias

It denotes investors' investing decisions based on several emotions, such as fear, greed, anger, excitement, etc. Such sentiments may be guided through the recent events or recent performance of the stocks/ schemes/ markets etc. This also explains why investors may get attached to individual stocks and refuse to book profits in such companies in anticipation of future profits, while the macros may have changed adversely. Such emotional investing may lead to holding on several underperforming schemes, thereby impacting the portfolio's health adversely. 

Investing biases may lead to several wrong investment decisions which one should aim to avoid. As such, one must focus on behavioural investing for a pleasant investment experience.