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Rational Ghost
Jun 28, 2022 8 min
Understand the rising popularity of index funds. This blog explores their benefits and how they can fit into your investment plan. This blog provides in-depth analysis and practical advice. These funds are suitable for long-term investors looking to save on taxes. They offer a unique combination of tax savings and potential for high returns over time.
On a fateful day in August 2010, a domestic aircraft belonging to FilAir (based in the Democratic Republic of Congo, Africa) crashed while approaching the Bandundu airport in Congo. The impact instantly killed 20 people on board, including the two pilots, leaving only one surviving passenger.
The investigation of the crash revealed puzzling findings. The Czech-made twin-engine was a relatively modern machine, well-serviced and well-fueled. The weather and visibility were favorable, and the two pilots were both qualified and experienced. Even the flight's black box contained no clues. From a technical perspective, there was no reason for that plane to have crashed.
The aircraft was simply approaching for a landing, and then nose-dived into a house just a kilometer short of the runway.
The lone surviving passenger unveiled this mystery. Apparently, one of the passengers sitting at the back, had been smuggling a young crocodile in a duffel bag on board. As the plane prepared for landing, the young crocodile wriggled loose from the luggage area at the back of the aircraft, where the crew was seated.
Spooked, the airhostesses ran to the front of the plane to inform the pilots, further alarming the passengers, who too, ignored the seat belt sign and rushed to the front. This shifted the entire passenger weight to the front of the plane, and the resulting shift in the aircraft’s center of gravity led to an irrecoverable loss of control.
The plane fell, at speed, nose first, into the ground. The pilots, crew, and passengers all lost their lives.
But guess what? The baby crocodile at the rear end of the plane lived. It crawled off the plane and escaped into the wilderness.
Source: The Mirror (UK)
This is an excellent parable to understand herd mentality, and how it overrides logic, reasoning, debate, and common sense. A small crocodile that in an ideal world could have caused nothing worse than a nasty bite caused an entire airplane to crash.
People were running, and so must we! People were doing something and more started doing it looking at them, so we should too!
People sold their stocks or MFs when the pandemic hit, and so must we. How often do we hear this!
An investor's decisions are generally heavily influenced by relatives, friends, colleagues, or neighbors' suggestions and actions. Especially when one is starting out or doesn’t have an expert consultant guiding them. If everybody around is investing in a particular stock, a potential investor may end up follow suit. It may not necessarily be the right fit in the portfolio, or even suit their risk profile, but because the acquaintances are all putting money in, why should we not?
It makes us feel comfortable. Why should I be ahead of, or away from the crowd and face all the risk by myself? What if I’m wrong and get left behind? If I’m right- I feel awesome. If not, I will at least not be miserable all by myself, as I follow ‘the herd’.
That is often how a bull, or a bear market is formed. A group of people starts buying shares of a company, resulting in the share price of that company rising. Some others look at these surging prices, and they feel if they don’t buy, they will get left behind- join the group. If everyone else is doing it, something must be right, after all! The group’s investing decision here is likely to be emotional and not rational.
And what’s the 'reason'? That the group buying these shares has some information that an individual is not privy to, and the group’s collective wisdom is leading them to make an informed choice. This builds a positive sentiment, and the market moves into a bullish run. The converse can happen to create a bear market - some investors offload their investment for whatever reason (tips, some incorrect analysis, some friend’s misinformed comment etc.), and 'market watchers' immediately react by following suit.
Remember the 90s’ infamous dot-com bubble? As soon as people realized that the miracle called the Internet could be monetized, investors of all stripes began to pour millions of dollars into a myriad of companies doing business online. These investments were majorly speculative- most hadn’t experienced it, but they felt there was money to be made- since many others were doing it. Thanks to herd mentality, interest remained spiked as more and more people pumped money into the tech companies, resulting in a bubble. Guess what? Many of these companies were supposedly so shady that they did not even have a product to begin with! They just rode the wave of investor interest in the tech space.
When the bubble popped in the early-2000s, scores of these 'new economy businesses' went belly up, and even more investors lost their life savings.
Starting with the Tulip bubble way back in the Dutch Golden Age in 1636 to the housing market bubble and even the Cryptocurrency bubble of 2018, history is rife with stories of economic bubbles as investors jumped aboard the investment bandwagon based on emotions rather than on sound financial strategy.
Closer home, look at the Sahara India scam! People did not understand how chits function. Still, because the security was recommended by a seemingly nice son, a daughter, a neighbor, or a boss who was part of the Sahara Parivar, society accepted it and continued to invest. There was no logic, no questioning of how the investment worked, no fingers raised until it was far too late. (FYI, Netflix has a mind-blowing documentary on the top scams and scamsters in India called the ‘Bad Boy Billionaires’. A must watch to also get some valuable investing lessons!).
Okay, it’s not totally horrible to have some psychological biases that influence decisions, including investing choices. It is only natural, in fact. And we’re familiar with it since our childhood. Don’t you remember your Mom or Dad going “If your friends jump off a cliff, will you too?” (Even at that time, depending on who my friends were, I might just have 😊 )
Looking back of course, no you won’t. But what if they were buying the latest iPhone, and showing it off at every possible instance? What if coffee-break discussions revolved around its latest features and notes were exchanged on tips and tricks of using the gadget? There is no guilt in accepting that you too may want to get yourself an iPhone. That is also what happens with investments. The fear of missing out (FOMO) plays a significant role, squeezing out any chances of a reasonable decision.
If you’re a parent, what you want to buy for your child is very often determined by the friends or classmates they have and the stuff they own- otherwise, we feel we get left behind. As we said- it is natural.
We have to stop caring about what Sharmaji-ka-beta does or did. A tough call, but that is the need of the hour. Here are 3 simple tips and strategies to follow when trying to avoid being a sheep in the markets.
Pause before you make an investment decision and ask yourself why it is a good idea. Just because everyone seems to be making a quick decision does not mean that is what you should do as well. Turn it into a habit to research well on what you are signing up for before making any investment. In the age of the internet, information is freely available at your fingertips. Make use of it. Find out what is it, what makes it a good investment, how much do you really know about it, what can go wrong, what it might cost you, how long do you want to invest in it and other key aspects, before putting your money on the table. This holds true even for managed investments like mutual funds.
To help you with this, we at DSP also give you an array of tools to analyze before you decide anything. Always be responsible and make an informed choice. Remember- an investment should never be an ‘impulse buy’.
This is a golden tip. Consulting a financial expert will leave you with better advice on your investments than what your family, friends or colleagues can give. Don’t be penny-wise and pound-foolish in this case. A financial advisor will understand your risk profile, help you plan for your goals by building a custom asset allocation and investment strategy tailored to your specific needs. Engaging an advisor also takes away your emotional involvement in decision making, and in all probability, leads to wealth creation and growth.
How to choose one? Watch the video below.
We understand that this is easier said than done. People often make decisions based on any justification they feel comfortable with. The reasoning for herding for example is the old age "strength in numbers" argument. Forcing yourself to form your own rational opinions independent of others may slow you down but will definitely lead to avoiding herd mentality and making informed decisions. One great suggestion an expert advisor made to me was to keep an investing journal documenting all the “Whys” behind each buy or sell decision I made.
If you’re still not sure whether you’re investing for the right reasons, heed Warren Buffett’s wise words:
And if you’re thinking, “Hey, so many can’t be wrong about this”, stop and remember Adolf Hitler. So many who followed him, couldn’t have been all wrong, could they?
FYI, a few historians have hypothesized that Adolf Hitler deliberately planted undercover German officers in his crowd during speeches and leveraged herd behavior. These officers were told to enthusiastically cheer for Hitler, encouraging everyone else to follow suit. This made it look as though the entire crowd supported Hitler. When these speeches would then be broadcasted to the larger public, this effect was further magnified.
Ok hang on, we won’t leave you on such a glum note. Here’s a link to a fun little video series #BreakTheBias - our endeavor to make you aware of various behavioral biases that can come in the way of good investing decisions. This 10 video-series from a couple of hilarious comedians showcases their own life insights & observations and will help you learn about cognitive biases in the best way possible - over a laugh or two!
The Rational Ghost. This is one rational storyteller that provides interesting insights & stories about investing and tries to be completely unemotional about it. Lives in the shadows, doesn’t want anyone to know its real name.
Disclaimer
This note is for information purposes only. In this material DSP Asset Managers Pvt Ltd (the AMC) has used information that is publicly available and is believed to be from reliable sources. While utmost care has been exercised, the author or the AMC does not warrant the completeness or accuracy of the information and disclaims all liabilities, losses and damages arising out of the use of this information. Readers, before acting on any information herein should make their own investigation & seek appropriate professional advice. Any sector(s)/ stock(s)/ issuer(s) mentioned do not constitute any recommendation and the AMC may or may not have any future position in these. All opinions/ figures/ charts/ graphs are as on date of publishing (or as at mentioned date) and are subject to change without notice. Any logos used may be trademarks™ or registered® trademarks of their respective holders, our usage does not imply any affiliation with or endorsement by them.
Past performance may or may not be sustained in the future and should not be used as a basis for comparison with other investments.
Mutual fund investments are subject to market risks, read all scheme related documents carefully.
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