When it comes to investing, emotions cloud our judgment! How to stay rational

• Investing is a complex process, and as humans, we are prone to emotional triggers, making us susceptible to errors in judgment and decision-making when it comes to investing.
  
• An investor may lose out because of an anchoring bias where he believes that the market has reached its peak.
  
• Fear can lead to selling when prices decline, while greed may encourage investors to chase quick gains in a heated market.
  

If you have to define a roller coaster, you may very well take a look at how the stock market has behaved over the first four months of this calendar year. From reaching an all-time high to mid- and small-cap led corrections and Sensex crossing the 75k mark to wobbling over the last few days due to tensions in the Middle East, the market has all the elements of an enthralling thriller.

But when the markets behave like this, or even during relatively stable times, investors tend to behave irrationally. Hersh Shefrin, Mario L. Belotti Professor of Finance at Leavey School of Business, emphasises that investing is a complex process, and as humans, we are prone to imperfections. Hersh is a renowned Canadian economist widely recognized for his groundbreaking contributions to behavioural finance and he says that we are all susceptible to errors in judgement and decision-making when it comes to investing.

While the key behavioural biases are well known, we will take a deeper dive into how they can influence our investing decisions.

Anchoring bias

One common bias that may affect investors is the anchoring bias which refers to the tendency of investors to rely too heavily on initial information when making decisions, even if new data suggests a different course of action. Gaurav Mashruwala, financial planner and author of Yogic Wealth, explains with an example. Let us assume that the stock is priced at ₹80. You are scared to invest for fear that the stock price will fall and decide to invest when the stock price comes down. However, when the stock price reaches ₹100 and then you invest thinking it will go up even higher. Say the stock reaches a price of ₹120.

An investor loses out because of an anchoring bias where you believe that the market has reached its peak. The opposite can also happen. When the markets are falling investors may rush to sell stocks for the fear of a loss and miss out on any potential recovery. Essentially, here one is a victim of anchoring bias because one is basing one’s decision on immediate information received and not considering other factors.

Base your investing decisions on rational thinking

Markets at an "all-time high", scream the headlines, when markets reach a peak. This may mislead people into thinking that the market will correct from that point because it has reached its highest level ever.

“However, there is no logical reason to assume that a correction will occur solely based on hitting a historical peak. Market movements are influenced by various factors, and historical highs do not guarantee an immediate correction,” says Chenthil Iyer, founder and chief strategist at Horus Financial Consultants, a financial planning firm.

Iyer says that the rational thing to do is to check whether the stocks in your portfolio have crossed their reasonable valuation fundamentally, i.e. based on its business parameters such as profits, expansion plans, product range, debt exposure etc. And if they have, then one may exit and wait for another opportunity. Else it would make sense to wait further.

“Doing well with money has a little to do with how smart you are and a lot to do with how you behave,” says Morgan Housel, the author of Psychology of Money.

Fear, greed, and panic

These human emotions tend to pay out under different circumstances and investing is no different. Suresh Sadagopan, founder and principal officer of Ladder7 Financial Advisories, a financial planning and wealth advisory firm, says, “There is a lot of noise at all points, especially during times such as these, and reports say that by the end of the Sensex will reach 75,000, 80,000 and so on. This will either generate fear or greed. If the reports are largely positive, it will generate greed. Otherwise, it will generate fear. A lot of information flowing in a particular direction will either bias you for or against.”

There may be some who think the markets will go up higher and put in more money while there would be others who feel that the markets have reached a point where it is at very high levels and decide to stop their SIPs and come back again in a few months. Either way, it is emotions of fear and greed taking over their investing decisions.

Fear, greed, and panic are common emotions that drive market behaviour. Fear can lead to selling when prices decline, while greed may encourage investors to chase quick gains. Panic can cause irrational selling during market downturns. Understanding and managing these emotions is essential for successful long-term investing.