Financial Literacy
Goal Based Investing
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A important first step in ones financial journey is having a clear financial goals and role of inflation and arriving at a monetary number for your goals. Having a good understanding of ones goal will aid in making better decisions about your finances, such as selecting right mutual fund portfolio that aligns with your goals. Additionally, understanding your own risk behavior and how you react to market downturns will help you develop a plan to handle such situations, instead of reacting impulsively.
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Behavioral Biases
What makes investment decisions complex is certain biases which serve us well elsewhere in life turn out to be detrimental to being a good investor. Having a good understanding of such behavioural biases and how they impact investment decisions is a crucial awareness in ones investment journey.
Each of us will have different biases to overcome and being aware and working to a plan despite these behavioral biases is key to investment success.
Behavioral biases are tendencies that can lead individuals to make irrational decisions.
Some of the most common behavioral biases in investment decisions include:
1. Overconfidence bias: This is the tendency to overestimate one's ability to predict future market movements and make profitable trades. This can lead to excessive trading and poor performance. This is what leads to investors tendency to time the market rather than allow investment time in market. Understanding even professionals find it hard to time the market investors can avoid overconfidence and stick to their investment portfolio allocation rules and Rebalancing.
2. Anchoring bias: This is the tendency to rely too heavily on the first piece of information encountered when making a decision, rather than considering all available information. This leads to making sub optimal decisions. One way to counter is to look for contradictory information or perspective to our original information and not make a decision in haste and spread the actions over time to test the original hypothesis.
3. Herding bias: This is the tendency to follow the crowd and invest in trending mutual funds or assets as others are doing. One way to counter this is to focus on one’s goals and time horizon and personalise ones mutual fund portfolio and just follow the plan. The strength of individual investor is to use his individual circumstances to his advantage and use the market to achieve his goals rather than swayed by crowd.
4. Confirmation bias: This is the tendency to seek out and believe information that confirms one's existing beliefs, rather than considering alternative perspectives. This also leads to sub optimal decisions. Considering alternative view points and allowing the market to confirm by taking a staggered and systematic approach can avoid decisions based on confirmation bias.
5. Loss aversion bias: This is the tendency to avoid taking risks in order to avoid losing money, rather than seeking out potentially profitable investments. It also means for similar sized loss and profit – losses are more painful for individual investors. One can counter this by building awareness and also understanding that the investments are goal based and one can wait till their time time horizon to recover form temporary losses. Ones own equity to debt allocation should also be tuned based on ones capacity to mentally take losses at portfolio level.
Primary Expertise
Our primary area of expertise, which is your profession through which money is made. For example as a doctor, scientist, engineer or artist, you will make money in your profession. In order to accumulate a significant amount of wealth, it's important to focus on your core skills and continue to grow within your profession. The surplus money generated from your primary source of income can be invested based on the right investment principles to grow your wealth.
A key ideas is to invest in yourself by expanding your skills, improving your social network, and building your career capital. This will help you increase your earning potential and channel more money into your savings and investments.
Summary
Following are the key points of how your own knowledge is key to your riches.
1. Understanding of fundamental investment principles and investment options
2. Understanding clearly one's own financial goals and timeframes to achieve them
3. Being aware of different behavior biases and having a plan for countering them
4. Goal based investing approach to both counter behaviour biases and adopt long term orientation
5. Investing in one's knowledge and building right support from mutual fund distributor or advisor to make informed decisions about their investments and set themselves up for financial success.
6. Expand own primary skills, building career capital and focus on improving earning potential.
