Our psychology plays an important role in investing. How our thought process is different in different situation? Why this type of thinking is harmful to a good investing management? What we should do to avoid different take in different situations?
Let’s discuss in this blog.
Investor Psychology
The other day I was talking to one of my clients. This was the time Share Markets were at the top. This client of mine had recently compared his investment portfolio with that of his friend’s portfolio. Incidentally, his friend also happens to be my client. He was surprised looking at the exceptionally good returns in his friend’s portfolio. The returns in his own portfolio were relatively low. He believed I was not paying fair attention to his portfolio. Had I been equally attentive to his portfolio as in case of his friend’s portfolio, his returns would also have been equally good.
Investment Expert’s Role
This was my turn to start the discussion all over again. I had to explain him about his Risk Profile (or Investment Profile) we had exercised while beginning his investments. I also had to remind him of his take (the way he reacted) on the portfolio when the markets were down during March 2020.
I have pulled out all the old records of this client. His Risk Profile was assessed to be Moderate. I had to remind him the discussion which we had while deciding his Risk Profile. As the Risk profile is Moderate, the Portfolio is expected to grow moderately but at the same time the Portfolio will not fall drastically during the markets fall. In other words, a Moderate Portfolio will fall less as compared to broader markets.
Here is Landscape of Risk Profiles –
- Defensive- Very Low Risk and Very Low Returns
- Conservative – Low Risk and Low Returns
- Moderate – Moderate Risk and Moderate Returns
- Growth – High Risk and High Returns
- Aggressive – Very High Risk and Very High Returns
To assess the Risk Profile, we conduct Risk Profiling activity of an Investor.
To assess your risk profile – Check your Risk Profile
Read – What Is The ‘Risk’ In An Investment And Why Is It The Most Important Factor In Investing?
Explaining Risk Profile
At this point I explained him that his Friend’s Risk Profile is Aggressive. Since his friend is willing to take the Risk, it’s but natural that he will earn better returns when the markets are high. But at the same time his portfolio has higher Risk too and will fall drastically when the markets will fall.
Coming back to March 2020, where this client’s portfolio fell around 15% when markets were down by almost 45%. He was still concerned about the fall in the portfolio. This proves that he has a low Risk-taking attitude. Had he seen his Friend’s portfolio during March 2020, which was down by almost 35%, how this client would have reacted?
Let’s understand the reaction of his Friend, who was assessed as an Aggressive Investor, during March 2020. When we had discussed fall in his portfolio, he was comfortable and was willing to wait for markets to improve, as suggested to him.
All of us think differently. However, we need to learn to be consistent in our thinking.
Read – “Return Kitna Milega?&”…This Is How I Answered My Client’s Question.
Designing a Portfolio
While designing a Portfolio, we consider Risk and Returns during the extreme situations. Fall in portfolio returns during the worst period tests a person’s psychology. Hence while designing a portfolio, we show him how a particular portfolio would have performed during the worst period. If he is still comfortable and is willing to accept the losses, notional though, probability is high that he will stand strong during this period. However, a person who is not very comfortable during the fall, he may behave erratically and can take or force to take wrong decisions during the worst period.
Read –6-Point Action Plan to Manage Investing Emotions
Expecting great returns when the markets are high but at the same time, not willing to accept the negative returns in portfolio when the markets are down, is an example of “Why somebody else’s queue moves faster than that of my queue&”. It’s just a feeling. A relatively conservative portfolio is better during the falls. But then this type of portfolio will have lesser returns during up-moves.
A consistent behavior over long run can reap much larger benefits than making un-necessary changes just looking at the market moves. This type of changes will kill the original objective and the investor will not be able to meet his goals.
At Bonvista we have tried to solve this problem by creating FundBox. FundBox are portfolios or combo of Mutual Funds schemes suitable to all investors. There are Conservative, Moderate and Aggressive FundBox. Investors can choose FundBox of their choice for every goal.
Visit our website www.bonvista.in and explore FundBox.
We are sure you will have a great experience!