The Biggest Threat to your Investment Decisions and What You can do about it!

One of my clients got a call from her mother when we were seriously building her portfolio. I enquired after seeing her panicky reaction. Her mother wanted my client’s son to be removed from a school immediately because there is an accident happened in the swimming pool. The student died during a swimming session. How correct the decision would be to take the child out of the school without understanding what exactly happened?

Be it good or bad, human mind takes decisions based on availability bias. Read ahead to understand the impact of availability bias in the investment decisions we make and how we can avoid this situation.

What is availability bias?

The availability bias is nothing but taking decisions influenced by the recent happenings or under dramatic circumstances. Most of the times, we make decisions based on such occurrences. Yes, we do this while investing our hard earned money.

What happens when you take investment decision influenced by availability bias?

How do you decide to buy or sell stocks? Do you just rely too much on immediately available information? It could be something you read in a paper, advice from your friend or hyped among investors. Do you know what happens when you take such decisions?

You must know about few incidents that happened in the recent past. India’s largest coal production company Coal India came public in 2010. It was known as ‘mother of Indian IPO’. Some even claimed that Coal India IPO would show the mountain to climb for the investors. The investors rushed and bought a high number of stocks. Look at it now, just within 3 years. As the coal prices and so the stocks going down, it is considered as the most dreadful investment option by the investors. The reliance IPO stands out as one more example here.

The same happened with the tech bubble in the end of 19s and the beginning of 20s. Everyone wanted to become an entrepreneur and holding some stocks that has ‘.com’ in its name. Not only in India, house bubble that occurred in USA is the perfect example of people loosing huge if the decision is taken because of availability bias. The reason is the popularity of the products.

How can we avoid falling a victim of availability bias?

Sir John Templeton, a brilliant investor and mutual fund pioneer, even advises us to avoid popular. He says, “Avoid the popular. When any methods of buying or selling stocks become popular, move on to the unpopular one”

Taking decisions based only on emotions, immediately available information, popularity leads to disaster. What can be done to avoid putting ourselves in such scenario? Study, study and study more about the product before investing in it.

Read, analyse and map with your goals while creating a portfolio. Invest in a product only when you have made enough research about it. Listen to what others are saying without having any prejudiced thoughts. Use the information collected from others just as pointers for your research, not for taking any major decisions. Analyse the pros and cons of each product.

Seeing any red flags in the portfolio. Do not ignore them. Dig more to understand why you have them in red. At the end of the research the red ones may become green and vice versa.

Bottomline:

Think about September 11 terrorist attack on the twin towers in America. Remember looking at the planes crashing at the twin towers and the fatality it brought in? Imagine, what would have happened if people chose to go by road instead of flying due to availability bias? Road accidents would have gone up. Whereas in reality, flight journey has become much safer due to the safety measures applied all over the world.

Likewise, not getting influenced by your emotions, the recent ups and down in the market, information from your friend or family is very important while taking the most important decisions about your investments.

Still feeling difficulty to get rid of these. Follow the simple exercise to get rid of availability bias.

-          Write about a product you want to buy or sell

-          Write about the reasons why you want to buy or sell

-       Take a break once written. Go out for walk, read a book, watch a nice movie or play with your child, so that you don’t think your investments.

After a break read the reasons again and again. You will get a clear picture on what exactly needs to be done now. Take your decisions brilliantly now!

K. Ramalingam is the chief financial planner at Holistic Investment Planners, a leading financial planning and wealth management company.

3 Questions to Answer before you Choose an Investment

                                       

3 Questions to answer before you choose an investment

When you plan to make an investment, you must be fully aware of the ins and outs of your investment. Therefore, a good advice is to find answers to a few very necessary questions, before you can actually decide upon an investment. Let us explore what these questions are, where an investor needs to lay his focus on before investing his hard-earned money.

1.       Do I have an Exit Strategy?

It is good to always plan your exit, before entry – especially in case of any investment acquisition.Wondering why? Because no investment can be convenient for you, forever. With time, your objectives are most likely to change. There is a reason behind you acquiring an investment. As those reasons contravene, it is the right time for you to make an exit without much delay. Therefore, it is important for you to know your exit reasons well in advance.

Exit can be healthy, in a condition when your investment turns feeble. Such a step then, will make a room for new growth to take place. Everything is volatile, so should your portfolio be. This will help keep it harmonious with the time.

There is nothing like a permanent investment. Therefore, you must always have your exit strategy pre-defined, to avoid your first loss from turning into your worst loss. You should always keep saving capital, to be prepared for investing in the very next opportunity. Trimming your portfolio of troubled investments, you are making a space for new growth opportunities.

2.       Did the investment pass the ‘business common sense’ test?

Every investment must have some business sense behind it, after all, investment is eventually about business. Your earnings, valuation and ROI must be compatible with the benefits and obstacles, possessed by the underlying business. It is really not a good thing if you lose money through your investment. This Business Common Sense test can be used with perseverance, to help you escape from troubling investment speculations and obsessions that may cause losses.

Here, one must know the Common Business Sense Test, to help them avoid getting stuck in a hoax. This test is not just limited to dodging manias and speculations, but the same can also be used to detect possible frauds.

Always remember that your investment is like a property on either your assets or the earning power of your business. Whether in case of debt, equity or real estate – one must eventually be able to make a business sense out of the promised returns. If that is not happening, then something is fishy. Never forget the common sense investment advice that if it’s sounding too good to be real, then it probably not is.

3.       How does the investment affect my portfolio’s risk profile and mathematical expectancy?

Never make an investment that either does not raise the overall returns in your portfolio, or lowers its risk. By matter of choice, you should aim for getting both these things accomplished. All of the investments should be therefore analyzed for their risk profile, and mathematical expectation on how much should they return over time.

Winning or losing the game of investing is entirely based upon your intensity in the front line. Therefore, you must ask the questions as mentioned above, till the time you have the answers for making a wise decision.

The bottom line

Finding answers to these diligence questions can help you save yourself from the most common, but very expensive down the road and help you retire rich and quick.The bottom line lies in building a well-diversified portfolio, for a consistent and long-term investment growth.

The author is Ramalingam K, CFP CM is the Chief Financial Planner at holisticinvestment.in, a leading Financial Planning and Wealth Management company

Investment Advisor Vs Financial Planner

A few decades ago, there was confusion with what sales and marketing are. People thought they are one and the same. But it is to be understood that sales is just an important ingredient of the functions of marketing. Sales lies in persuading and convincing a person to buy a product that is suitable. Marketing involves all the activities right from the conception of the product, to branding, advertising and retailing. It is an all pervasive function from the product being ready to reach the market and ultimately to being sold to the customer. 

Today here prevails a similar confusion with who is an investment advisor and who is the financial planner.  It is quite common to find these terms used interchangeably, but it is necessary to understand that an investment advisor and a financial planner have the similar and vast differences as between sales and marketing. 

Why is this confusion?

There is a real confusion among the investors regarding who a financial planner is and who is an investment advisor. These terms are used very loosely, so it is necessary that one understands the function of each of these professionals and approach the right people.

The main confusion in these terminologies arises out of a person’s own perception. This arises due to most professionals offering financial services like insurance advisors, mutual fund distributors and stock brokers calling themselves financial planners. This term has been used very loosely by many to suit their own convenience and image.  This is more like a compounder professing to be a doctor, when he/she knows purely only about the medicine that one has to dispense. A compounder will not have the expertise to diagnose the disease that needs to be treated.

 

Who is the Financial Planner?

Financial planner is involved in planning all the finances of a person. His job includes drawing up an appropriate plan that covers all financial needs and goals in the short, medium and long run. Such a planner is like an architect of a building and helps to analyze and draw a complete map of how his or her client’s finances need to be planned. It includes considering the need for liquidity, cash management for various needs, goals planning and feasibility, long term cash flow, estate planning and risk management.

Who is an Investment Advisor?

In contrast an investment advisory/advisor is a person or group that helps his client to decide on the financial products that he or she should invest in. Such an advisor understands what his or her client actually wants after communicating with him or her and understanding the need. An investment advisor makes a thorough analysis of the various securities before doing so.

Hence investment advisory is just one of the ingredients of financial planning.

Goal Achievability:

A financial planner will be able to tell you, is it possible to achieve all your financial dreams with your current and projected earning capacity. If it is not possible, then the financial planner will be able to tell you what could be achieved with your earning capacity and to achieve all your dreams what kind of earning capacity you should have.

Risk Management Plan:

A financial Plan also covers creating a risk management plan. A risk management plan includes creating an emergency reserve, assessing the human life value and suggesting a term insurance; identifying medical insurance cover required and suggesting a health insurance plan; and also suggesting a general insurance policy to cover the natural perils like fire, flood, earthquake … against your properties.

Investment Plan:

A financial plan that suggests investments comes only after all the aspects have been analyzed fully. The best investment advice can only flow out after a deep analysis of a client’s need and after the preparation of a financial plan. Financial Planning should precede the investment planning.

Existing Portfolio Revamp:

It is also necessary to understand that a financial planner also looks at past investments. He then makes necessary changes to make them amicable to achieve a client’s financial goals over a period of time. Also he will assist you in restructuring your existing outstanding loans. If necessary he will create a debt pay-off plan also.

Tax Planning:

A financial planner should assist you in creating a tax plan also. This tax plan will be in sync with your overall financial plan.

Review:

A financial planner will do a periodic review on your financial plan and investment plan. If you are preponing or postponing one of your goal or if you have got a job promotion, then you may need a financial plan review. If direct tax code has got implemented or one of your investment schemes underperforming, then you may need an investment review.

In a nutshell a financial planner will not only give you an investment advice he assists you in managing your personal finance in a complete, comprehensive and a holistic way.

The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the  Director and Chief Financial planner of Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached at ramalingam@holisticinvestment.in.