Cognitively Yours 1.0
"Emotional reactions of investing in equity have often diverged from the cognitive assessment of risk of investing in equity"
Friends! Welcome to the series Cognitively
Yours. It is an endeavour to explain what biases affect our plan to accumulate
wealth. In a series we discuss biases which make us stumble into mental
pitfalls.
The market is at all-time high and has done
extraordinarily well during the last nine months. Whether investors have done
well? Even over long term the equity markets have provided decent returns, but
not all investors have benefited by it. Emotional reactions of investing in
equity have often diverged from the cognitive assessment of risk of investing
in equity. Fear of equity has done more damage than investing in equity.
Financial decisions are made in situations
of complexity and uncertainty which prevent us from relying on fixed rules and
also compel us to rely on intuitions. When faced with complex problems like
investing for future, retirement planning etc., where the variables like amount
of savings, expected returns, future needs etc. are uncertain, we resort to
mental shortcuts.
We rely on such shortcuts so that the complex tasks of assessing probabilities and predicting those future values and events are replaced by much simpler judgmental operations. Such shortcuts can help us take quick decisions, but they may ultimately lead to severe and systematic errors due to our biased beliefs.
Not only in finance, Mental shortcuts are resorted in all fields. For example, in cricket where a batsman hits the ball to the deep and runs to gather runs. To decide whether to run a single, take a double or not run at all, the batsman has to compare the time taken to run with the time taken by the fielder to throw the ball at the stumps. This calculation has to account for the speed with which the ball travels to the fielder, time taken by the fielder to pick up the ball, the speed and the trajectory at which he throws the ball at the wickets etc. However, the batsman gets very little time to decide if he should run and hence has to rely on intuition and fine tune it depending upon his past successes. The back of the envelope calculations though imperfect cannot be done away with. But we have to recognise the mistakes and errors- others mistakes as well as our own. Ignoring them will be at our own risk.
This blog captures the correct mindset of investors predominantly...
ReplyDelete....over long terms equity markets have provided decent returns....
ReplyDeleteOur knowledge about whether people make or lose money over long terms is anecdotal. The NAV returns published by Fund houses are mechanical and unhuman. Instead they should publish median redemption yields to understand how humans have been faring in equity market.