Behavioural science is the branch of science that–among a lot of other things–explores and analyses how our behavioural traits affect the decisions we make. There are two kinds of decisions that humans take–cognitive and emotional. On a broad level, the cognitive decisions are rational decisions that are taken by the brain; the emotional decisions are influenced by the heart and may be irrational. In life, there is space for both types of decisions. Some decisions have to be shaped by emotions while some decisions should have as little emotional influence as possible. Investment decisions fall in the second category.
It doesn’t need to be said that investment-related decisions require deep understanding and logic. By and large, they cannot be influenced by emotions. And yet, we let that happen. We let our emotional behaviour take decisions that should have been driven by rationales.
This tendency can have a majorly detrimental effect on our investment portfolios, particularly the investments that we make in equity linked savings schemes (ELSS). These are tax-saving mutual funds that earn you a tax break of up to Rs 1.5 lakh under Section 80C of the Income Tax Act. ELSS funds come with a lock-in period of 3 years and are considered to be one of the finest tax-saving investment options. These mutual funds invest in the stock markets and it is their equity exposure that makes them risky.
Club this equity-related risk with human behaviour and you have the recipe for investment decisions that can go awry. However, ELSS funds are worth the risks they come with because they are the only tax-saving investment that can generate inflation-beating returns. To get the best out of ELSS funds, all you need to do is invest systematically and not let your emotions override your cognitives decision-making abilities.
Here are three common behavioural tendencies that can affect your ELSS investments and how you should avoid that from happening:
Equity-oriented investments need to be looked at a little skeptically. Overconfidence affects ELSS investments when investors ignore the basics and try to time the markets. But many investors fall for this trap because they become overconfident. They try to time the market and invariably that leads to a bad investment decision because a crash in the markets can lead to heavy erosion of the invested amount.
The way around this behavioural trait is by choosing the SIP route for investment. The best way to invest in ELSS funds is through a systematic investment plan (SIP). SIPs allow you average out your cost of acquisition and stop you from catching a market peak that can happen if you invest in lump sum.
What happens when the stock markets plummet? The country’s economy gets into a stress and so do the investors. It is understandable if stock brokers or market speculators get stressed by the daily gyrations of the broader indices, but ELSS fund investors shouldn’t be getting carried away by the market’s movements. In fact, they should rejoice if the markets fall because that would turn into a buying opportunity that would lead to growth over the long-term.
The way to avoid letting stress affect your ELSS investments is by continuing your SIPs even through the rough weather. Don’t consider pulling out or stopping regular investments when the markets are in a bear phase. Stay put and continue investing. The low market valuations will allow you to buy more ELSS fund units and help your investment portfolio generate higher returns when the markets turn around.
Herd mentality is when you follow what everyone else is doing without analysing if that thing is actually good for you as well. This happens a lot when it comes to equity-oriented investments. People choose and invest in an ELSS fund that is the most popular one. But that may not always be the correct choice.
The right way to choose an ELSS fund is on the basis of the investor’s risk profile and investment goals. All ELSS funds earn a tax break, but they have different investment styles and approaches. There are aggressive ELSS funds and conservative ones. Some ELSS funds have a growth orientation while some follow the value style of investing. You should not pick a fund that is popular because everyone is investing in it, you should pick a fund that matches your needs.
In a nutshell, these are behaviours that we need to guard our investment decisions against. The heart might want what the heart wants, but it is the mind that has better cognitive abilities to take decisions that can affect our financial health.
This article was also published on Yahoo Finance on 18 May 2016.
Image courtesy of iosphere at FreeDigitalPhotos.net.