Executive Summary: Behavioural biases affect people’s capability to make the right investment decisions. In this post we talk about  Loss Aversion, Herd Mentality, Sunk Fallacy and Self Attribution. In the previous post, we talked about – Confirmation Bias, Familiarity Bias, Hindsight Bias and Endowment Effect. 

Emotions during financial planning can lead to behavioural biases that can prove detrimental to investment success. In the second post on behavioural biases, we look at a few more biases and how they affect investment decisions –
Loss Aversion
We tend to feel the pain of loss much more than the joy of gain. We are more willing to prevent losses than make equivalent gains. A loss of Rs. 1000 makes us doubly saddened as compared to joy of gaining Rs. 1000. This is one reason why penalties for mistakes work better than rewards for good behaviour.
How can it affect your Portfolio

• Not selling loss making investments in the hope that they might be profitable someday.
• Staying away from good investment products when prices are falling thus losing an opportunity to buy at low costs.
• Investing most of the savings in safe investment products that provide less than optimal returns. This leads to an imperfect investment portfolio. 

How can you overcome it

• Take a long-term view on your investments.
• Be logical and make decisions based on facts.

Herd Mentality
Individuals doing the same thing as others in the group so that they conform to the norm. It makes one feel safe. For example, if all your colleagues own the latest iPhone, you buy it too. If many people subscribing to an IPO, others tend to do it too making it oversubscribed. But if the IPO does not offer value, even if it lists at a good price, its value drops. 
How can it affect your Portfolio

• You might be late in joining the herd leading to higher buying costs.
• When the value is dropping, you sell in panic. You might be selling off good quality assets the value of which will bounce back.

How can you overcome it

• Invest as per the asset allocation model that suits your financial profile.
• Check with your financial advisor about the investment product you want to invest in.

Sunk Cost Fallacy 
Sunk cost is the price already incurred and cannot be recovered. For example, you invest in a stock. The price goes down and you buy some more trying to average the cost. The price goes down further and you hear bad news about it. But instead of selling, you buy even more trying to reduce the cost. You buy a car and after some years, it gives lots of problems. But you still spend money trying to repair it thinking it is an expensive asset.
You do not realise that you are spending a lot of time, money and effort in salvaging the money spent earlier. 
How can it affect your Portfolio

• Your portfolio has loss making investments.

How can you overcome it

• Find out other alternatives to invest in.
• Identify and cut your losses. 

Self Attribution
The tendency of a person to credit himself for successful outcomes and blame circumstances etc. for bad outcomes. For example, in a car accident, both parties blame the other. When a person makes a big profit in the stock market, he is quick to take credit for his investment acumen but blames the market, the political scenario and everyone else when he makes a loss.
How can it affect your Portfolio

• You may tend to not pay heed to the advice of the financial advisor but follow your decisions which may backfire.
• You do not acknowledge that you may not be making the best investment decisions. This leads to a skewed investment portfolio. 
• You do not try to improve your financial quotient.

How can you overcome it –

• Evaluate the decisions you have made honestly and acknowledge how much of it can be attributed to you.
• Acknowledge your failures and use them to learn and adapt.

Do you think you have experienced any of these biases? How did you overcome them?