The 3 Top Behavioural Traps Mutual Fund Investors Need to Watch Out For Right Now
With their collective AUM (Assets under Management) soaring towards the 20-lakh crore mark, Mutual Funds have become a very popular investment tool these days, with thousands of investors choosing to switch over to them from the safe haven of traditional investments. It is estimated that nearly Rs. 5,000 Crores flows into Mutual Funds automatically each month, through SIP’s (Systematic Investment Plans). However, it’s worth noting that many first-time investors who have started investing into Mutual Funds in the past five years have never really been face to face with a market downturn. It’s when things head south that Mutual Fund investors tend to act irrationally. Irrespective of whether you’re a seasoned investor or new to Mutual Funds, here are the 3 top behavioural traps you must be wary of right now.
The Action bias is the innate tendency to want to constantly “do something” with your investments. Although Mutual Funds work best when you’re relatively passive with your investments, the Action Bias could force you to constantly tweak your portfolio, by way of taking profits too frequently, redeeming and redeploying into different funds often, or changing your overall asset allocation more often than needed. However, this could result in your taking short term decisions that could be detrimental for your overall portfolio returns in the long run. Once you decide upon your optimal asset allocation and invest into a portfolio of top quality Mutual Funds, it’s best to stay put; only rebalancing your portfolio once a year in a disciplined manner.
Loss Aversion Bias
If you jumped in to invest when the NIFTY briefly soared past the 10K mark a few weeks back, you could be sitting on short-term losses right now. In such a situation, you might end up acting in haste due to the loss aversion bias – the tendency of short term losses generating stronger feelings than usual. The loss aversion bias might prompt you to exit your investments early if markets were to start correcting further from this point. You could start questioning your decision to invest. However – remember that markets tend to be fickle and volatile in the short term. If you jump ship at the hint of losses, you may end up playing the role of spectator when cycles reverse, and you’re unable to muster up the courage to jump back in. If you’re investing in Mutual Funds, especially equity oriented ones, it’s best not to be fazed by short term losses. Remember that stock markets tend to recover and move up over longer timeframes. Stay put and fight the tendency to look at your portfolio too often – this could further fuel the loss aversion bias.
The Conservatism Bias is the human tendency to change our opinions too slowly, even when presented with evidence pointing us in the opposite direction than the one we’re walking on. For example, you may have been bullish on the markets for a long time, and therefore favoured high risk mid and small cap funds. However, today’s rich valuations and absence of significant earnings growth warrant a more cautioned approach to investing. If you fail to adapt to changing trends and continue hanging on to your preordained point of view for too long, you may end up taking regrettable investment decisions. The reverse applies too. You may have been bearish on the markets for the past few years; and if a deep correction were to come (thereby seconding your view), markets might actually become cheap. However, if you continue to be bearish even when valuations become cheap, you’ll miss out on valuable opportunities to invest. Best to dispassionately adapt to market trends, instead of hanging on to a specific viewpoint. Markets are bigger than all of us.