Why do some people succeed in investing while others don’t? You can ask the same question about entrepreneurship too. Why do some people succeed as entrepreneurs while others don’t? While the answer may lie in hard facts and investing skills, there is a major issue of behavioural biases in investing. We are all conditioned to think and act in a particular manner and over time that becomes our behaviour. There are certain key behavioural biases in investment decision making which can keep you from being a successful investor. Let us look at how to overcome these behavioural biases in investors.
When you lack the patience to watch your money grow
Investing is not for the short haul. That is trading! If you want to become a successful investor then you need to make patience a specific part of your behaviour. Why is patience so critical? Typically, good companies take a long time to become good investments. For example, the IT sector first showed promise in the late 1980s but it was only by the late 1990s that it actually reached a tipping point and managed to reward investors. When equities reach the tipping point, the stock returns from that point is geometric. But that is only possible if you the patience and the capacity to take a real long term view. That is a key behavioural aspect of your investment success.
When you lack the discipline to stick to your investment plan
Be it a trader or an investor, discipline is the key. What do we understand by discipline? A disciplined investor goes through two steps; first he plans his work and then he works his plan. If you miss out on either of these steps then you are not a disciplined investor and are unlikely to savour too much of investment success. Never get into investing without making a complete documentation of how you intend to identify stocks; how you will monitor positions, what will trigger decision shifts etc? It is equally important to go by your plan and avoid deviations altogether. The moment you falter in your investing discipline, it will show in your investment performance.
When you tend to become greedy and fearful at the wrong times
This is a common behavioural constraint most investors face. Smart investors identify good buying opportunities when the markets are extremely fearful and everyone is panicking in the market. That is the time to get greedy. Similarly, when valuations are rich, it is time to get fearful but that is when the herd instinct leads most investors to buy. You need to have the behavioural courage to be greedy when others are fearful and to be fearful when others are greedy.
Your risk capacity and risk tolerance do not synchronize
This is again an extremely psychological phenomenon. While risk capacity refers to how much risk you can take, risk tolerance shows how much risk you are willing to take. The behavioural problem comes when your risk capacity and risk tolerance are not aligned. For example if you have a higher risk capacity due to your wealth but you have low risk tolerance then you are likely to make sub-optimal investments that will not help you to create wealth. On the other hand if you have low risk capacity but a high risk tolerance then you could get into dangerous situations where you may end up taking blind risks that you cannot afford. To be successful in investing, your risk tolerance needs to be aligned to your risk capacity.
When you get too macro and ignore the micros
A lot of investors believe that investing is all about focusing on the large macro issues and that the micros will be taken care of. That is not the way it works. So people tend to focus on strategy and themes but ignore smaller issues like costs and execution. That is a recipe for making sub-optimal investment decisions. Make it part of your mental make-up to look at the details. More often than not, the devil lies in the details. Get into the micro issues, get into how orders are placed, whether market orders work better or limit orders work better, get into technical charts, get into brokerage and statutory costs etc. You will end up being a better investor by focusing on micros rather than purely on macros.
When you tend to procrastinate on decision making
This is the last, and perhaps, the most important condition for success in investing. Think through your investment decision thoroughly, but once you have made the decision to invest or divest a stock don’t wait too long for the execution. When you are making a decision don’t spend too much time considering the alternatives. Use data to the extent possible and then go with your gut. That is how the best of investors operate. Firstly avoid procrastinating on decisions. Secondly, once a decision is made don’t spend too much time doing a what-if analysis. Grab the lesson and move on!
These are some of the behavioural issues that prevent investors from being more successful. For sure; these rules are likely to help you too…