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Investment Decision Cycle & Behavioral Biases

The Investment Decision Process

Every investment goes through a systematic cycle, and behavioral biases can distort decision-making at each stage.

The Cycle:

  • Goal Setting → Define investment objectives
  • Information Gathering → Research and analysis
  • Evaluation & Selection → Choose investments
  • Execution → Place orders, build portfolio
  • Monitoring & Review → Track performance, rebalance

Biases at Each Stage

Goal Setting Stage

Biases That Interfere:

Overoptimism: Setting unrealistic return expectations.

  • "I'll earn 30% annually" (market average is ~12%).
  • Leads to insufficient savings, excessive risk-taking.

Present Bias: Under-prioritizing long-term goals.

  • Retirement feels too distant to save for seriously.
  • Result: Chronic under-saving (average Indian saves less than needed).

Anchoring on Past Returns: Expecting recent performance to continue.

  • Bull market means "Stocks always go up".
  • Bear market means "Stocks are dead".

Information Gathering Stage

Confirmation Bias: Seeking information that supports existing views.

  • Bullish on stock means ignoring contradictory evidence.

Availability Bias: Overweighting easily recalled information.

  • Recent IPO success implies "All IPOs are great".
  • Vivid crash memories lead to overestimated risk.

Information Overload: Paralysis from too much data.

  • Too many mutual funds leads to analysis paralysis.

Evaluation & Selection Stage

Representativeness: Judging by similarity to prototypes.

  • "This startup founder is like the next big tech CEO".
  • Ignoring base rates (most startups fail).

Recency Bias: Overweighting recent performance.

  • Chasing last year's top-performing mutual fund.

Herd Behavior: Following the crowd.

  • "Everyone is buying this stock, it must be good".

Home Bias: Preferring domestic/familiar investments.

  • Indian investor concentrating 90%+ in Indian stocks.

Execution Stage

Timing Bias: Trying to time the market.

  • Wait for "perfect" entry point and miss rally.

Action Bias: Feeling need to "do something".

  • Markets volatile leads to excessive trading.

Regret Aversion: Avoiding decisions that might cause regret.

  • Don't buy falling stock, don't sell rising stock.

Monitoring & Review Stage

Disposition Effect: Sell winners too early, hold losers too long.

  • Winners: "Lock in gains".
  • Losers: "Wait for break even".
  • Cost: Annual underperformance.

Myopic Loss Aversion: Checking portfolio too frequently.

  • Daily checks make short-term losses loom large.

Hindsight Bias: "I knew that would happen".

  • Prevents genuine learning from mistakes.

Narrow Framing: Evaluating each investment separately.

  • Ignoring: Portfolio as whole.

Breaking the Bias Cycle

Goal Setting:

  • Use historical data for realistic expectations.
  • Visualize future self to combat present bias.

Information Gathering:

  • Actively seek disconfirming evidence.
  • Use checklists to avoid availability bias.

Evaluation:

  • Use quantitative screens.
  • Check base rates.
  • Diversify automatically.

Execution:

  • Use SIPs to eliminate timing decisions.
  • Set rules: "Invest systematically".
  • Automate where possible.

Monitoring:

  • Review quarterly, not daily.
  • Pre-commit to rebalancing rules.
  • Track both winners and losers objectively.

Case Example: Complete Cycle

Investor: Rajesh, Age 35, Bangalore

Goal Setting (Bad): "I want to retire rich".

  • Better: "₹2 crore by age 60".

Information (Bad): Only reads bull market stories.

  • Better: Reviews both bull and bear cases.

Evaluation (Bad): Chases last year's top fund.

  • Better: Selects low-cost index fund.

Execution (Bad): Waits for market correction.

  • Better: Starts monthly SIP immediately.

Monitoring (Bad): Checks portfolio daily.

  • Better: Quarterly review, stayed invested.

Outcome:

  • Bad approach: Lost money selling at bottom.
  • Better approach: Gained wealth by staying disciplined.

Key Takeaways

  • Every stage has behavioral pitfalls: goal setting, information, evaluation, execution, monitoring.
  • Awareness is first defense—recognize which biases affect you.
  • Rules beat discretion—pre-commit to systematic approaches.
  • Automation removes temptation—SIPs, auto-rebalancing.
  • Long-term perspective combats myopia—quarterly reviews, not daily.

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