For how long will you be able to keep quiet without doing anything, that is, if you are not meditating? 5 minutes? 15 minutes? Half an hour? I am sure you will be bored after that. Even if you are silently watching Facebook or Instagram, will you not react to posts? I am sure you will. This is because we all love action. We feel restless if we do not do anything. This constant need to do something is called action bias.The same is true with investing.
This is part of investing too. Have you seen how the markets always seem to be in action? There are a lot of news, views and experts’ comments always around the markets. All of them talk about events happening that might affect investments such as the union budget, elections, Reserve Bank of India (RBI) interest rates,etc. Based on the information, investors decide to buy or sell their investments. Lets understand what action bias in investing is.
Most people believe that they need to do something with their investments constantly. They think they should always be taking some action to protect their investment portfolio or improve their returns. They feel scared if they do not do anything! Here’s why that might not always be the right thing for your portfolio. Action bias just keeps us busy but it does not always lead us to more wealth or better returns. Read on to know more.
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When we invest, we want to take some action because we believe taking action will improve our returns and help build more wealth. But that is not always right, especially if you have invested in the long run. Many times, you may lose money if you take some action in panic or you buy or sell investments hastily after checking some news or views. You might have seen other people reacting badly to some news items and selling their stocks in a panic. This leads to a fall in the prices of those stocks and there is more panic. Then, what happens? More people sell it off that stock leading to erosion of value for the stock. Action bias is what causes this reaction.
Another result of a bad dose of action bias is over-trading. Just because other people are buying a stock and it’s moving up, you but that stock. There might be thousands of others like you who might buy that stock. Then, what happens? That stock is over-valued and you might be paying a premium for buying that stock.
The desire for a sense of control leads to unnecessary trading. This could be because of – boredom, overconfidence, chasing new ideas or even blind panic. Over-trading has costs and these costs might lower the returns from your investments.
Behavioral finance professors Brad Barber and Terrance Odean researched over-trading in 2000. They found that individual investors pay a “tremendous performance penalty” for active trading. They found that the average portfolio saw a 75 percent annual turnover. The commission fees on those trades lowered returns. Even transaction costs have undoubtedly come down, the more you trade the more costs you incur. So, action bias can lead people to over-trade.
Now that you know what is action bias, let us see how you can stop it from influencing you.
Techniques to Avoid Action Bias
Be Patient
Markets will keep going up and down in the short term and the long term. You won’t always be able to buy and sell at best prices. So, all you need to do is to be silent if you have chosen the right investments. Even if your investments are reflecting a loss, if you have researched well and chosen the right investment, it will bounce back in some time.
So, the antidote to action bias is patience. It demands a huge amount of self-control. It is the key ingredient in long-term buy-and-hold investing. Warren Buffet says “Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient. “The more patient you are, the better will be the results.
Mark Minervini, in his book Think and Trade Like a Champion, urges investors and traders to develop “sit-out power”. He uses an analogy of a cheetah waiting for a wounded antelope. The cheetah might be starving but it’s smart enough not to waste its energy on a low-probability kill.
You need to think and observe what is happening. Start analyzing the situation and then make an investment decision. When you do this, you are sitting idle. You are doing something. You are not biased but can wait and watch. You can then make the right move.
If you are tempted to take an investment action, ask yourself why you want to make the decision. Think through the pros and cons and then decide whether an action is needed.
Also read: 7 Behavioural Biases affecting Investor Returns
Do not keep tracking investments
Heard of that guy who keeps looking at his stock investment every day? He makes losses and profits every other day. Well, there are many investors out there who do this. Stocks and mutual funds are meant to be long term investments. A long-term investor should not care about the price shifts and volatility in the short-term. If you keep checking your portfolio, you might get influenced by action bias.
It is best not to evaluate the performance of your portfolio frequently. You can do this once a year for long term investments. Unless there is some news relating to your stocks or mutual funds, do not look at them.
Invest according to your risk profile
A good financial planner will always ask you about your risk profile. You need to make investments as per your risk profile. If you don’t invest this way, action bias could affect you. How? For example, if you have a low-risk appetite and you invest in equities, you will be more likely to keep tracking your investments, especially when they are reflecting a loss in the short-term. You might sell the stock because you think it might make further losses. This may not be right. The stock might do well in the long run if it is fundamentally strong.
Before you start investing, ask yourself if you are a low, medium or high-risk taker. This will help you choose the right investments and will help you avoid action bias.
Also read: What Investors Can Learn From Prospect Theory Or The Loss Aversion
Choose investment experts carefully
Heard of people who have made a killing in the stock market? What about those bitcoin investments or corporate bonds where people got big money? It all might appear exciting. Such stories might tempt you to take action to increase your portfolio returns. However, you need to be careful with these investments. You might want to take the help of investment experts to invest in high-return products. However, this could be risky.
Getting rich quick is not the right strategy
Financial planners or Registered investment advisers will tell you that you should invest only in regulated financial products that can be easily bought & sold in the market. They will teach you how you should invest as per your financial requirements, present market conditions and using some common sense. An Investment Adviser will help you accomplish optimal risk adjusted return on your portfolio. Action bias is inherent in humans. You should have an investment strategy to overcome it. However, it is more important to know when to take necessary action on your portfolio. This is where an investment adviser like MoneySage can help!
