Behavioral Finance is something which is attracting a lot of attention these days. Increased volatility in the markets has brought psychology back into economics. Now what is Behavioral Finance? “Behavioral finance attempts to explain how and why emotions and cognitive errors influence investors and create stock market anomalies such as bubbles and crashes”. So questions like why people make errors despite knowing everything, why people start following others despite not knowing the details, why people start taking decisions without any solid logic can be answered through Behavioral finance. According to Warrant Buffet, “Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ…Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.” But very few people have this temperament. Most of the best brains go wrong. Herd mentality takes over. Why? You know the answer.
Recently I got a fine example of this theory. There is a very senior guy in our office whose main motive for coming to office is to chat with people. He has no work and is unallocated for the last one year. So he keeps moving from desk to desk and keeps chatting on various topics. If he visits a person, he spends at least 15 minutes there. Doesn’t matter even if the other guy is in the middle of an important call. He will wait. Today he came to visit my friend. I sit just opposite him and so I tried my best to not to look at him. My friend had no escape route. They started discussing on stocks. My friend then suddenly called me and asked “Can you please explain to Sir why his ULIP is not making any profit for the last three years”?
Well I had no way out. I was forced to join the conversation. I asked him to give me some details about his ULIPs, his switching strategy etc. He told that he had invested around four lakhs in a ULIP some three years back. He is presently at a 30% loss. Now this looked strange. Achieving this kind of a negative return in the Indian equity market over the last three year is next to impossible. Something must have happened. I asked him where he has parked his money. He told in the growth fund which has 80% equity allocation and rest debt. Then I asked him if he keeps switching frequently. He told yes. Whenever the markets go down he switches his money to a debt fund which has 80% allocation in debt and rest in equity. This he does to protect his money. Whenever the markets go up significantly he switches his money back to the growth fund again. Now I understood. To put this simply let us assume he has bought his ULIP units at Rs 10. Over a period of say six months his unit value becomes Rs 14. He is in profit. Now suddenly the markets tank. His fund value goes down. When his unit price goes down below Rs 10, he panics. Let’s assume he sells of his units at Rs 9 just to cut down his loss and puts the money in a debt fund. When markets goes up and the unit value moves up to Rs 15 he switches his fund to the growth fund (80% equity allocation) again. So he ends up buying units at Rs 15. This strategy he diligently followed over the last three years. No wonder he is at a huge loss. When I explained him how he was making a loss every time he is switching he was thunderstruck. I could see grief in his eyes. I felt pity for him.
I think this is a very good example of behavioral finance.
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This is my observation canvas! These are my opinions, my stories, my rantings, my bitching about everything under the sun. And this is also the place where I laugh at myself! And I hope to share the laughter with you too, dearest visitor. One more thing..if you donot like something in this blog do let me know. Like the pictures..all via google images..if you have a problem just inform me. And there might be loads of mistakes in my writing...point it out then pls forgive and forget..ok?
