How you can Avoid Behavioural Blindspots in your Investment Decisions

The picture below shows two yellow lines on a railway track. 

Can you tell which one is longer? Is it the one closer to you? Or is it the one farther to you?

You just have 5 seconds to answer. 

If you’re like the rest of us, the line which is farther to you will appear longer. 

But here comes the surprise – both the lines are exactly the same length!

You can check the image below to verify. 

While our intuition (read as gut feel) usually does a good job for most of our decisions, in certain contexts, they end up misguiding us. The above illustration is a classic case.

And here comes the tough part. Even if you know about this illusion, it’s difficult to unsee this illusion the next time. 

So what is the solution?

Simple. Don’t go by your intuition. Use a RULER. 

Drawing a parallel, in investing there are a lot of situations where your clients’ gut feelings and intuitions misguide them to take the wrong decisions. These decisions while they ‘feel’ right in the short term have a significant adverse impact on their long-term investment outcomes. 

While a lot has been written about behavioral biases (read as quick shortcuts used by the brain to make decisions) the actual problem is not about awareness or knowledge. 

The real problem is that – it’s insanely difficult to implement counter-intuitive decisions on a regular basis especially when the stakes are high and money is involved!

This is where your clients need a RULER equivalent in investing to help them take the right investment decisions. 


The Power of Frameworks

Think about frameworks as a set of investment principles, strategies, or rule-based guidelines that will guide your investment decisions. They should be evidence-based, repeatable, and behaviourally aligned to their personality. 

By organizing information better, it will help you focus on the few key variables that matter (vital few vs trivial many), and by reducing emotions and human biases, frameworks can help them make good investment decisions on a consistent basis.

Instead of me explaining the need for frameworks, let me take the help of the world’s greatest investor to do the job for me 🙂

“To invest successfully, one doesn’t need a stratospheric IQ. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework” – Warren Buffett

So the key idea is to start developing investment frameworks based on long-term evidence and behavioural insights for you. This can also act as a good defense mechanism against behavioural errors and emotional decisions. 

6 Ps of Behavioral errors

While there are several behavioural errors, here are the 6Ps of Behavioural Errors that cause the maximum damage. 

  1. Panic Selling
    • Seen during equity market falls, Bear Markets 
    • Eg 2008 Global Financial Crisis Decline, 2020 Covid Crash
  2. Profit Booking
    • Seen during equity market all-time highs
  3. Procrastination in Deploying Money
    • Seen during all-time highs, amidst bad news (which somehow is always the case)
    • When equity markets go up it feels like it’s bound to fall and when markets fall, it feels like they will fall further
  4. Panic Buying
    • Seen in Bubble Markets, Fear of Missing Out, Chasing Fads
    • Eg Crypto, Tech Stocks, etc
  5. Predictions From Experts
    • At all points in time, some Expert is predicting a market crash
  6. Performance Chasing
    • Buying and Selling funds only based on past performance – not understanding the cyclicality of outperformance
    • Chasing Sector funds based on performance

Frameworks can be a good solution to address the above errors. 

How can you build your own investment frameworks?

Here are some important investment decisions for which you will need to build frameworks. It’s beyond the scope of this article to explain all the below in detail, though we will keep adding blogs for framework down the course of time – so stay tuned.

  1. Framework to Decide Long-Term Asset Allocation (blog page)
    • Helps you to decide the asset allocation split across equity and debt
  2. Framework to evaluate where we are in the Equity market cycle 
    • How to evaluate if you are in Bull, Bubble, or Bear Markets 
  3. Rebalancing Framework (blog page)
    • When and How you can Rebalance their Asset Allocation
  4. Crisis Framework (blog page)
    • How to convert a market crisis into an opportunity 
  5. Bubble Market Framework (blog page)
    • Bubble Market Indicator
    • Plan to go underweight Equities in a Bubble Market
  6. Framework to construct Equity Fund Portfolio
    • Active vs Passive
    • How to diversify across investment styles and geographies?
    • Fund Selection Process
  7. Framework to construct Debt Fund Portfolio
    • How to build debt portfolios managing credit risk and duration
    • Framework to evaluate interest rate cycle?
    • Fund Selection Process
  8. Framework to Invest lumpsum money
  1. Framework to Invest via SIP (blog page)
    • 7-5-3-1 Framework
  2. Framework to exit as you reach your goals

You can use the above list as a starting point to think through different investment decisions which require a framework. Once you finalise on your list, you can gradually start building your own frameworks and keep evolving them over time based on feedback. 

Summing it up

I would like to leave 3 key action items for you

  1. You should pre-decide and put in place evidence-based investment frameworks for different investment decisions and scenarios
  2. You can document the above using an ‘Investment Policy Statement’ 
  3. You should keep the 6Ps of behavioural errors in mind

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