In Behavioural Finance — Part 1 we saw an overview of what comprised behavioural finance. We understood that our behaviour towards our investments will define our wealth creation journey.
While i can go on and on writing about this subject, I’ll try and limit the subject to its specifics.
Let us understand the behavioural biases that people in general face
1. Thinking that real estate is risk free and that land prices always appreciate in a linear fashion — It is important to understand that real estate is just like any other market driven by supply & demand. It is futile to expect that prices will move only upwards. Real Estate market (Land and other assets) has its own cycle of booms and busts. The only reason why people think that it makes money and it has done so historically is because ancestrally our mind has been ingrained into understanding that land is an asset to be bought and kept and not sold. So we hold it for the long term only to realise that it created wealth. Well if it is true for real estate, logically, shouldn’t it be true for equities too! Ultimately even equity is also an asset class. Think! (Fact Check — Sensex was Rs 100 in 1980. It is 47000 in 2021. That is a return of 47,000%. Your money has been multiplied 470 times.. Think! This level of wealth creation is not even seen in real estate. Go and check whichever data you can for the Indian real estate market. I’ll be glad to know)
2. Thinking that gold is safe — Let’s understand the fact the gold is also driven by greed and fear. You can go back through history and see for yourself the trend of gold prices. Even gold has had it’s share of ups and downs. It is again not an asset with linear returns. It can generate returns provided you stay invested for a long period of time. But it has definitely not beaten equities over a long term time frame.
Below is 40 year data and returns of assets from the year 1980 till Aug 2020:
3. Thinking FDs are safe — I’m sure you must have become familiar with what happened in Yes Bank, PMC Bank and other cooperative banks where even FD investment were at stake. The DICGC insures only up-to 5L of Fixed Deposits across banks for a particular investor. Do you still think FDs are completely safe and there is no default risk? Think again. In contrast one’s investment in FDs is vulnerable to high concentration risk because investors end up investing in a single financial institution’s FD over a period of time without any due diligence of the risk the FD holds.
4. Thinking equity/stock market is a gamble — Let us understand and get one thing very clear. No investment is ever a gamble. It is only when one doesn’t know anything about it is when one perceives it to be a gamble out of ignorance and less knowledge. But yes, investment avenues without any fundamental basis purely riding on some frenzy and crazy news or trending because it is the next big thing can definitely be called as gambling. You need to watch out for that!
So is equity market a gamble — Answer is NO. In equity markets we have shares of companies being traded/invested in. Companies in turn have tangible and intangible assets and people and employees working to run the company. The company is utilizing some resources to generate revenue and hence profits/loss (depending on how the company is faring). So we definitely have underlying value for those shares. The investor’s decision to buy that share is most likely due to the company’s past performance and your expectation and conviction of the future performance of the company. So the investor is definitely thinking of the future value that will be created by that company. How is it a gamble then? It is calculated risk. The investor might have invested thinking that the company would perform and hence the stock price would rise and he/she would profit. Reverse happened and the stock came down. The investor/trader might have probably not done this for a long term time frame and done with the intent of short term gains for trading. He/she might have lost out. He/she took a short term bet — Gambled! That does not make the stock market a casino. The stock market is there for the investor to leverage its resources for your use. It is up-to the investor to decide how to control the behavioural biases and profit out of it.
So it is important for the investor in any asset class to control the behavioural biases. It is only then that the investor would not get swayed by the ups and downs of the any investment class and would end up creating wealth over the long term.
Keep Investing & Stay Invested. Happy Investing!
