When was the last time you wanted to go on a diet? When it comes to implementing a diet or any other plan, many of us often fail. That is why systematic investments make behavioural sense, be it for direct equity, fixed deposits or mutual funds. How?
Systematic investments typically operate on an auto-debit principle. You instruct your brokerage firm, bank or mutual fund company to debit your bank account on a periodic basis, say, monthly. The auto-debit principle is useful because you are unlikely to find time to manage your investments every month. Besides, work pressure from modern-day corporate life is likely to leave you stressed more often than not. When you are stressed, your logical brain is overpowered by your intuitive brain. And intuition may not always be right. Systematic investments eliminate the need to take action when you are stressed.
RECENCY EFFECT
Another issue related to manual or non-systematic investment is that you may suffer from recency effect. That is, if you recently witnessed a stock market crash, you are more likely to shy away from the market because you perceive higher risk in such investments. And if you recently witnessed sharp rise in equity prices, you may be willing to take more risk, expecting prices to move up further. Systematic investments moderate your perception of risk because of the auto-debit principle.
Sometimes, you may have lump-sum, cash received as bonus from your employer or what your grandmother gifted you for the New Year. In such cases, you may have the choice to invest either lump-sum or systematically over a period of time. Now, investing systematically moderates two biases — loss aversion effect and anchoring effect. Suppose you invest lump-sum and the investment value declines thereafter. If you are typical investor, you will most likely hold the investment till it comes back to your purchase price. This is called anchoring effect, as you are ‘anchored’ to your purchase price. And because you are anchored, you will not sell the investment at a loss. In other words, you will be willing to hold on to your loss-making position even if it means taking more risk, for the investment could further decline in value. This is called the loss aversion effect, your tendency to hold loss-making investments. When you make systematic investments, you do not have a single reference point. Hence, price anchoring is not so obvious. And this in turn could help you moderate loss aversion bias as well.
You may be unable to create a mechanical process to implement all your plans. But you can at least do so for your investments.
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