Investor attitude for positive returns


Investment decisions are based on instincts and not information. And that these behavior patterns are predictable. A Psychologist won the Nobel Prize in Economics about 4 years ago. His award-winning work showed how an investor’s behavior affects his or her investment decisions.

Affluent investors take mental shortcuts which may lead to wrong investment decisions. Given below are some of them:

* Most affluent investors tend to ‘over-rely’ on their own judgment. Even if they work with a financial advisor, they expect the expert to produce higher-than-market returns. Good investors should look for long-term, consistent returns, and not the latest hot stock in the market.

* The rich investors often attempt to predict the future from the past. To expect a stock to rise today because it rose yesterday is like saying it will rain today because it rained yesterday. Many people make judgments based solely on recent returns.

* To judge the likelihood of an event, investors tend to search their memory resulting in biased estimates. For instance, if asked to think of an English word with the letter ‘e’ in it, most choose a word beginning with ‘e’ whereas there are three times as many words with ‘e’ as the third letter — make, like, take etc.

* Investors tend to go by what they read about a stock in newspapers rather than evaluate its fundamentals.

* Affluent investors are prone to ‘following the crowd.’ During the tech bubble of the 1990s more the excitement more was the investment until finally everyone realized that they were over-paying for the opportunities. If you hear about a hot new investment at a cock tail party, chances are the value has already been reflected in the market. Herd mentality will give chasing returns instead of accomplishing goals.

* Investors who have cash surpluses are not averse to risks; they are averse to losses. Let us consider the following case as an example, (a) Win Rs 800,000, or (b) have 80 percent chance of winning Rs1,000,000 (in other words, a 20 per cent chance of winning nothing). Now choose between (a) losing Rs 800,000 and (b) an 80 percent chance of losing Rs1,000,000 or conversely a 20 per cent chance of losing nothing.

Most people chose (a) in the first part and (b) in the second. Even though the two situations had the same probability, people chose to avoid a loss rather than win more. The way a decision is framed affects the outcome.

To decide on a risky investment, the investor has to think in terms of personal outcome. If he is right, he will make a handsome profit; if he is wrong, he will have to work three more years until retirement.

What is important is how much risk one need to take rather than how much risk one wants to take. Investors should know if the risk is appropriate to the return they expect. Using these tools the investor can manage expectations of return and attitude towards investing.