Swaying with market mood often leads investors to buy during bubbles and sell during crashes, a behavior unlikely to yield superior returns,” says Nimesh Chandan, CIO, Bajaj Finserv AMC. As markets hit all-time highs, many retail investors face “FOMO” (Fear of Missing Out). Neuroeconomics explains that humans are naturally inclined to short-term thinking and emotional biases, making FOMO common in such scenarios. Others, who booked profits early and await a correction to re-enter, may experience regret. Navigating these markets requires good planning and discipline. Start by creating a financial or asset allocation plan aligned with long-term goals. Consider the equity market’s base rate of long-term returns and its inherent volatility. Excitement around certain themes or sectors can drive valuations up, while areas ignored due to short-term challenges may offer better long-term opportunities. Seeking professional advice can help design a robust investment plan for wealth creation.
Retail investors often follow herding behavior, joining market rallies despite potential pitfalls. Contrarian investing—going against the crowd—demands emotional strength (Behavioral Edge) rather than just knowledge (Information Edge). Independent thinking is crucial: assess whether the crowd is overreacting or underreacting. This requires thorough research on businesses, valuations, and megatrends, along with a disciplined investment process. By resisting impulsive decisions and avoiding herd mentality, investors can focus on sustainable, long-term wealth creation.
He also highlights that overconfidence leads to mistakes in investment decisions and to investors taking too many risks. Overconfidence is a consequence of a few basic biases. The first is confirmation bias, which can be addressed by seeking out counter arguments to our own ideas. And another important source of overconfidence is the Availability Heuristic: a tendency to assume that our memories are a representative sample of reality. To handle this heuristic, investors need to follow a set process which involves collecting the right data and calculate probabilities of risk and return correctly. Being successful at one investment can lead to illusion of superiority and overconfidence in the ability to consistently deliver favorable results. It is important that investors keep an investment journal to later analyze and dissect the outcome between luck and skill thereby aiding better decision-making.
During market booms, investors tend to anchor their expectations to recent market performance, expecting the trend to continue, and in this, Anchoring bias may not be avoidable, but decisions can be guided to the right data with conscious effort. Some of the ways to handle anchoring: Assume that one is always vulnerable to anchoring to noise and hence consciously remove irrelevant information or noise from discussions. Fundamental investors are better off focusing on fundamental values rather than anchoring on technical data. Always, try to find a counter argument. Make an independent estimate of the company before looking at market valuation. And finally, use long term trends and base rate to forecast.
Mr. Chandan also points out that Investors may face the “disposition effect,” where they hold on to losing stocks for too long and sell winners too quickly. It is an effect of a problem in the sell discipline of the investors. Unfortunately, not much attention has been given to this aspect in the investment literature. Pre-commitment is an idea that can help handle disposition effect. Whenever an investment is being considered, make a scenario analysis and design stop-losses or triggers that will make you change the stance. It is better done before the money is committed to the investment and when one is not emotionally attached to the asset. Set up automatic stop-losses, portfolio shifts from one asset to another and event triggers to avoid falling into the trap of disposition effect.
Market highs can cause a “wealth effect,” making investors feel wealthier and more inclined to spend or invest aggressively. This impact is also called the house money effect. A nonprofessional gambler will typically have money in two mental accounts: the own money account and the ‘house money’ account. The profits from winning are kept in ‘house money’ account (casino being called the house). The gambler treats this money differently as she assumes that her own money is safe with her, she is just gambling with the money she has taken away from the casino. Unfortunately, the risks she takes with this money will be higher than amount in the own money account. This effect is seen in traders too. After an initial success, the house money effect makes them take larger risks. This stops them from moving smoothly towards their financial goals. Ultimately, they lose the money back in the market. Investors need to stick to the investment plan even when they make more returns than they expected.
With markets at record highs, many investors struggle with “myopic loss aversion,” reacting to short-term fluctuations and exiting prematurely. Equity markets offer strong long-term returns, so avoid timing corrections. Focus on fundamentals, adjust only for material changes, and maintain emotional discipline. Stick to a long-term plan, avoid daily portfolio reviews, and distinguish information from noise. Use a sound investment process and adopt a broad asset allocation view, add Mr. Chandan.
