NISM Series V-A Mutual Fund Distributors Certification Examination
Ch 1 - Investment Landscape
In this video, you will learn about the Behavioral Biases in Investment Decision Making
*Behavioral Biases in Investment Decision Making
-The risk is not only related to the investments, but to the role of emotions in decision making, or in other words the irrational behavior of investors towards management of money.
-Investors are driven by emotions and biases. The most dominant emotions are fear, greed and hope.
*Availability Heuristics
In the investing world, this means that enough research is not undertaken for evaluating investment options. This leads to missing out on critical information, especially pertaining to various investment risks.
*Confirmation Bias
This is the tendency to look for additional information that confirms to their already held beliefs or views. It also means interpreting new information to confirm the views. In other words, investors decide first and then look for data to support their views. The downside is very similar to the previous one – investors tend to miss out on many risks
*Familiarity Bias
An individual tends to prefer the familiar over the novel, as the popular proverb goes, “A known devil is better than an unknown angel.” This leads an investor to concentrate the investments in what is familiar, which at times prevents one from exploring better opportunities, as well as from a meaningful diversification.
*Herd Mentality
“Man is a social animal” – Human beings love to be part of a group. While this behavior has helped our ancestors survive in hostile situations and against powerful animals, this often works against investors' interests in the financial markets. There are numerous examples, where simply being against the herd has been the most profitable strategy.
*Loss Aversion
Loss aversion explains people's tendency to prefer avoiding losses to acquiring equivalent gains: it is better not to lose Rs. 5,000 than to gain Rs. 5,000. Such behavior often leads people to stay away from profitable opportunities, due to the perception of high risks, even when the risk could be very low. This was first identified by Psychologists Daniel Kahneman and Amos Tversky. Kahneman went on to win Nobel Prize in Economics, later on.
*Confidence bias
This bias refers to a person’s overconfidence in one’s abilities or judgment. This leads one to believe that one is far better than others at something, whereas the reality may be quite different. Under the spell of such a bias, one tends to lower the guards and take on risks without proper assessment.
*Recency Bias
The impact of recent events on decision-making can be very strong. This applies equally to positive and negative experiences. Investors tend to extrapolate the event into the future and expect a repeat. A bear market or a financial crisis leads people to prefer safe assets. Similarly, a bull market makes people allocate more than what is advised for risky assets. The recent experience overrides analysis in decision-making.
*CHOICE PARALYSIS
Too many choices result in postponed decisions. This inability to choose is known as decision paralysis (and also known as choice paralysis or analysis paralysis) and it is an insidious enemy.
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