Mutual funds have become widely popular in the last two decades due to their convenience factor. Thanks to the fintech boom in India, several apps and platforms are available to help beginners and professional investors alike in their investment and financial planning journey.
When you are ready to start your investment journey, you need a reliable ally, right? Koshex is one of the most versatile apps, providing a range of benefits to its users. It provides a customized experience by analyzing your behavioral pattern and investment objectives. Sign up here!
A key challenge for most investors pertains to selecting funds. And this is where biases come into the picture. This article will shed light on:
- What are investment biases?
- Common biases among investors worldwide.
- Ways to avoid these biases while making your financial decisions.
What are biases while selecting funds?
Biases are a strong feeling of favoring one group of a particular object over the others. The object can be groups of people, facts during an argument, or mutual fund schemes, in our case.
Imagine you have Rs. 10,000 with you. Several questions can come to your mind regarding what to do with it, such as:
- Should you invest the money, or should you spend it?
- If you decide to invest, where should you invest it?
- What kind of returns can you expect?
- Will you lose the money if you decide to invest?
- What kind of performance data should you look at?
We will help you find answers to some of these questions by looking at the five common investment decision-based biases known as behavioral biases. We will also explain how you can avoid them.
#1. Loss aversion bias
What is it: This is one of the most common behavioral biases where someone fears losing something. Like many spheres of your life, it applies to your financial decisions.
Since mutual funds are market-related investments, there is as much chance of making a loss as a profit. No amount of research or expertise can remove the chances of making a loss completely.
It is a common behavioral pattern that people feel the pain of loss more than the happiness of a gain. Hence, to avoid loss, they prefer not to invest at all. This is commonly known as loss aversion bias.
This is one of the primary reasons why people save instead of investing. They prefer to keep their money idle in the bank to avoid loss. However, they fail to understand that even if they keep their money idle, inflation will erode its value.
How can you avoid it: During a loss aversion bias, you start avoiding even small risks worth taking to maximize returns. The best way to avoid this bias is not to get emotionally attached to the investment and accept loss as a part of the investing process.
While the chances of loss cannot be removed completely, following a decision-based investment approach can help you gauge the market well and reduce the chances of making a loss.
#2. Anchoring bias
What is it: This is one of the cognitive biases where an investor uses one criterion to measure all the different factors while selecting funds. They use one common filter for judging all the different criteria associated with mutual funds.
This is quite a common bias in mutual fund investing. The most common example is estimating a mutual fund’s future returns based on past returns.
How can you avoid it: Mutual funds are advanced investment products with many factors associated with them. You need to weigh in several factors while choosing a mutual fund scheme.
Taking the above example forward, instead of looking only at past returns, considering factors such as the overall market condition and the theme of the mutual fund, comparing several mutual funds with similar themes can help you avoid this bias.
#3. Recency bias
What is it: In these kinds of investment biases, an investor tends to make decisions based on recent events rather than the actual performance trend. They tend to go for mutual fund schemes that have done well recently, even though they may have performed dismally in the past. They feel that recent events will continue forever.
How can you avoid it: It is important to remember that just because a mutual fund is doing well now doesn’t mean it will continue to give you good returns. Every industry goes through a cycle of boom and bust. A classic example would be the IT industry, booming in the late 1990s but dipping massively towards the beginning of the 2000s.
The best way to avoid recency bias is to stay clear of sudden sensations to avoid making poor decisions. Keep your portfolio diversified so that the steady performance of another can compensate for the slump of one industry.
#4. Overconfidence bias
What is it: Has one mutual fund scheme in your portfolio given you exceptional returns this year? Is this motivating you to invest further in that scheme?
People tend to feel invincible when things are going well. Decisions taken in this mental state often tend to be poor decisions. This is known as overconfidence bias, another common behavioral bias.
How can you avoid it: Feeling happy and confident about your portfolio’s performance is okay. However, it is important to base all your investing decisions on research and analysis only. Consider different data sets, take the help of financial apps such as Koshex, analyze the performance of various mutual funds, and then make the final decision.
#5. Herd investment bias
What is it: Another common cognitive bias is herd investing. Investors across the world fall prey to this.
In this bias, one tends to invest where everyone else is investing. When most investors invest in a mutual fund scheme, people tend to think it is the right choice. Such decisions are not based on analysis but on general market consensus.
How can you avoid it: While the funds where the majority of investing may be good funds, they may not necessarily be the right ones for you. Every investor has a different investment objective and risk profile. You need to assess your investor profile and make decisions accordingly.
If you are a beginner and not confident about making your own decision, shed all biases when it comes to investments. Data is a good tool to use when it comes to overcoming biases related to investments. Tracking the overall performance of your preferred mutual fund or choice of investment will also help bolster confidence about the next steps.
Be thorough with your research and take the help of a reliable and trustworthy investment app such as Koshex, which offers specific insights that are tailor-made for your profile, financial needs, and objectives. This helps you avoid all the biases we have discussed above automatically. Remember, Koshex works as your trustworthy, financial touchpoint.
Don’t miss this opportunity. Sign Up today to explore all the benefits of Koshex.
Frequently Asked Questions
- What are the five 5 biases that people have when investing?
Several biases are associated with mutual fund investing, the most common five are as follows:
- Loss aversion bias
- Anchoring bias
- Recency bias
- Overconfidence bias
- Herd investment bias
- What does bias mean in a mutual fund?
The decision to invest in a mutual fund is often guided by some preconceived notion that they prefer one mutual fund over another. This is known as mutual fund investment bias.