ET Wealth | 6 principles to avoid losing money

Of all the species on the planet, human beings are arguably the ones with the best cognitive abilities. However, life tests, and sometimes severely, our ability to make good decisions. Daniel Kahneman, who passed away on 27 March at the age of 90, told us that our ability to make good decisions is not as easy as it appears. We rely too much on intuition for decisions that need deep and analytical thinking. Nowhere is this more apparent than in the process of making financial decisions. Here are the six mistakes Kahneman points out that can help investors avoid big money losses.

1.The Halo Effect

The tendency to like everything about a person/management towards which investors have an affinity.

A prime example is Asian Paints, a company that has been the darling of fund managers who look at ‘quality’ as their biggest parameter. These are companies that have high price-to-earnings (PE) ratios, but have built a ‘halo effect’, which basically states that irrespective of their valuations, these stocks will continue to give high returns. Over the past one year, the Asian Paints share has moved up by only 2%, against 30% rise in the Nifty. Even on a fiveyear basis, Asian Paints has lagged the Nifty. While the Nifty 50 rose 92%, Asian Paints rose 90%. The company had a PE ratio of 98x in 2021-22, which has now come down to almost 50x.

As valuations fall, the ‘halo effect’ will disappear, but during that time, investors will suffer a massive opportunity cost. But there are fund managers who have stacked up on the stock and believe that eventually the quality premium (‘halo effect’) will be back.

2.The law of small numbers

Jumping to big conclusions about a stock from an analysis of very limited data or sample.


There is a general belief that small companies give higher returns in terms of their stock prices, compared to large caps. However, the fact is that small-cap companies also give extremely low returns. Since we look at a small sample of smalland mid-cap companies that have done well, the inference is that there are no losers. In fact, there are an equal number of companies that have underperformed, but we only looked at the winners in this space, which was a limited number.

3.Sunk cost fallacy

When you keep investing in something even when it is past its prime.


In 2018, investors in the YES Bank stock kept buying during the dips in the hope that the bank would eventually turn around. That never happened, and the stock underperformed for a very long time.

4.Illusion of pundits

Believing star commentators because they seem to know where the market is headed.

There is an extremely charismatic and articulate fund manager and is probably one of the best financial markets communicators in the Indian market. Investors have invested in his PMS only because they thought that since he explains valuations better than anybody else, he will give the best returns. Over the past one, two and even three years, all his funds have consistently underperformed.

5.Loss aversion

Preferring sure-shot but sub-optimal returns over high returns, which have a slight chance of loss.


A typical LIC moneyback policy gives a return of less than 6%. Investors do not like losses. They know that losses hurt two times more than profits. In such a situation, they would rather bet on something that gives them less profit, but guarantees some returns. Typically, this is the reason most people still prefer to put money in fixed deposits, gold and, sometimes, even real estate, where they believe that the chances of losses are low. Even when they invest in equities, they prefer the quality factor that comprises companies like Asian Paints and HDFC Bank, where the belief is that these will never make losses.

6.Overconfidence

It won’t ever happen to me.


A study by Sebi shows that derivative traders lose money 90% of the time. Most of these traders operate on instincts, and they believe that since they have been good at something, they will be good at trading derivatives as well. More often than not, they lose. Overconfidence also affects professional traders and investors, who do not follow their own risk management systems as they start to depend more on their instinct than process-driven thinking.

product launches

:: MUTUAL FUNDS


Tata Mutual Fund will launch the Tata Nifty Auto Index Fund, an openended thematic equity fund that will invest in the constituents of the Nifty Auto Index in the same proportion as their weight in the index. The benchmark of the fund is the Nifty Auto Index TRI. The minimum investment is Rs.5,000. The NFO will be open from 8 to 22 April.

Tata Mutual Fund will launch the Tata Nifty Financial Services Index Fund, an open-ended sectoral equity fund that will invest in the constituents of the Nifty Financial Services Index in the same proportion as their weight in the index. The benchmark of the fund is the Nifty Financial Services Index TRI. The minimum investment is Rs.5,000. The NFO will be open from 8 to 22 April.

Tata Mutual Fund will launch the Tata Nifty MidSmall Healthcare Index Fund, an open-ended sectoral equity fund that will invest in the constituents of the Nifty MidSmall Healthcare Index in the same proportion as their weight in the index. The benchmark of the fund is the Nifty MidSmall Healthcare TRI. The minimum investment is Rs.5,000. The NFO will be open from 8 to 22 April.

Tata Mutual Fund will launch the Tata Nifty Realty Index Fund, an openended thematic equity fund that will invest in the constituents of the Nifty Realty Index in the same proportion as their weight in the index. The benchmark of the fund is the Nifty Realty Index TRI. The minimum investment is Rs.5,000. The NFO will be open from 8 to 22 April.

Trust Mutual Fund will launch the Trust Flexicap Fund, an open-ended diversified equity fund that will invest in stocks across all market capitalisations. The benchmark of the fund is the Nifty 500 TRI. The minimum investment is Rs.1,000. The NFO will be open from 5 to 19 April.

PGIM India Mutual Fund has launched the PGIM India Retirement Fund, a multi-cap equity fund that will invest in a mix of stocks, REITs, InvITs and fixed income securities. Its benchmark is the S&P BSE 500 TRI. The minimum investment is Rs.5,000. The NFO is open till 9 April.

BANKING

Prodigy Finance has announced five scholarships worth $5,000 for the academic year 2024-25. Students from a Prodigy Finance supported region and looking to do their postgraduation in foreign universities supported by Prodigy can apply. Applications are open till 30 April.

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