Behavioural finance: the psychology needed for investors in Namibia
By Arney Tjaronda
BBA Student: Banking & Finance Major (UNAM).
Investors fail to understand the very core principle when it comes to investing and that is the behaviour aspect. Having the right investment strategy, top notch research does not always guarantee success if you do not have the right mindset. That is what will be disclosed in this piece.
Understanding Behavioural Finance
As eluded by Business Insider (Feb 4, 2021):” Behavioural finance is a field of study that tries to identify and explain biases that cause people to make irrational investment decisions or behave in financially detrimental ways.”
Investing is about having the right psychology to make better rewarding decisions to increase performance and value of your investment portfolio. Institutional investors usually conduct experiments and research to illustrate a situation most of us would not have a problem with. These experiments are important because humans are not always rational, therefore their decision-making can be flawed.
Understanding behavioural finance is important because it enhances your perception on different investment strategies and evaluate the level of certainty that comes with it. Behavioural finance helps to improve your emotional intelligence as an investor so that emotions like greed, fear, pride and euphoria does not affect your decision-making. It is so important that because of greed alone, the renowned scientist Isaac Newton lost a lot of money on the South China Sea bubble of 1720. This is why it is important to understand behavioural finance and its importance when dealing with investments.
Behavioural finance concepts
These concepts are crucial to understand as an investor because it identifies where one’s logic is.
• Mental accounting is the propensity for people to allocate money for specific purposes
• Herd behaviour is a method whereby investors tend to mimic the financial behavior of what everyone else in the market is doing.
• Emotional gap is when investors make decisions based on what they are feeling, example; fear, excitement, anger and greed
• Self-attribution is when an investor makes decisions based on the overconfidence in one’s knowledge or skills.
Some bias revealed by behavioural finance
Here we are to disclosed some bias identified for behavioural finance analysis. The following information is not presented as my own but was retrieved from an article ini Investopedia (08 May 2021).
Familiarity bias is identified when an investor always invests in what they know such as locally owned companies. As a result, investors are not diversified across multiple sectors and types of investments, which can help reduce the risk of their portfolios. A good example of some investment companies in Namibia is those that mainly focus on purchasing shares in local businesses as a pooled investment (private equity). Some of these investment companies, in which I will not disclose their names, incurred tremendous losses when the companies they invested in failed due to the COVID-19 pandemic. Such loses could have been mitigated if they diversified their portfolios rather than just sticking to what they know.
Loss aversion bias occurs when the investor place vast concern on the losses they might get, rather than the pleasure from potential market gains. This type of mentality is adopted by the “old” financial institutions in Namibia that has the traditional “fail proof” business model that avoids risks from investments instruments which may have higher potential gains. Although these financial institutions have steady long-term returns, their return never seize to change if one was to project their overall returns against market Index charts.
Lastly, the confirmation bias, which is when investors are keen on accepting information that confirms their already-held belief in an investment. When information of a certain security surfaces, especially if the material agrees with the investor’s belief, they will use it to make their investment decision even if the information is flawed.
In conclusion, behavioural finance is very important and should be taken seriously because it can help elevate your success when making investment decisions. They say the hardest battle starts from the mind, therefore if you want to succeed as an investor in Namibia, discipline your mind and do not pay too much attention to only one person’s opinion.