The Psychology of Investing: Staying Grounded in a Bull Market

As equity markets hit all-time highs, investors face increasing psychological pressures, says Nimesh Chandan, CIO at Bajaj Finserv AMC. Many fall prey to “FOMO” (Fear of Missing Out), leading to impulsive decisions that often result in buying during bubbles and selling during crashes. This behavior, driven by emotional biases and short-term thinking, rarely produces superior returns.

According to neuroeconomics, humans are naturally inclined toward short-term thinking. While some investors grapple with FOMO, others who booked early profits may regret missing further gains, waiting for corrections to re-enter the market. To combat these tendencies, Chandan emphasizes the importance of creating a long-term financial plan and sticking to it. Aligning investments with personal goals and understanding the equity market’s base rate of returns, coupled with its volatility, are essential.

Behavioral Pitfalls and the Importance of Independent Thinking

Retail investors often exhibit herd behavior, following market trends despite potential risks. Chandan advocates for contrarian investing, which requires emotional strength—what he calls a “Behavioral Edge”—alongside knowledge. Independent thinking and thorough research into businesses, valuations, and megatrends are critical. By avoiding herd mentality and focusing on disciplined decision-making, investors can aim for sustainable wealth creation.

Overconfidence is another common trap. Investors often take excessive risks due to biases like confirmation bias (favoring information that supports their beliefs) and the availability heuristic (relying on memorable but unrepresentative examples). Chandan suggests countering these biases by seeking diverse perspectives, following a structured investment process, and keeping an investment journal to analyze the role of luck versus skill in outcomes.

Avoiding Anchoring and the Disposition Effect

During market booms, investors frequently fall victim to anchoring bias, basing decisions on recent trends rather than fundamentals. Chandan recommends focusing on long-term data, removing irrelevant noise, and making independent assessments of a company’s value. He also highlights the disposition effect, where investors hold on to losing stocks for too long while selling winners prematurely. To address this, he advises setting pre-commitment strategies like stop-losses and portfolio shifts before emotional biases take hold.

The “Wealth Effect” and Myopic Loss Aversion

Market highs can create a “wealth effect,” leading investors to feel wealthier and take larger risks, akin to a gambler’s “house money” effect. This often results in aggressive investments that derail long-term financial goals. Chandan warns against deviating from a sound investment plan, even when returns exceed expectations.

Investors also face myopic loss aversion, where short-term market fluctuations prompt premature exits. Chandan advises focusing on fundamentals, adjusting only for material changes, and maintaining emotional discipline. He encourages investors to avoid frequent portfolio reviews and to distinguish meaningful information from noise.

Key Takeaways for Long-Term Success

Chandan concludes by emphasizing the importance of a robust investment strategy:

• Plan and Discipline: Align investments with long-term goals and stick to a structured process.

• Independent Thinking: Evaluate markets critically and avoid following the crowd.

• Focus on Fundamentals: Use data-driven insights to guide decisions and avoid emotional biases.

• Professional Guidance: Seek expert advice to design a resilient investment plan.

By understanding and managing behavioral biases, investors can navigate market highs effectively, ensuring sustainable wealth creation.