A. Behavioural Reasons
The Dalbar Quantitative Analysis of Investor Behavior (QAIB) consistently shows that individual investors underperform the broader market. This is largely because they tend to wait for clear signals or positive momentum before investing, often driven by the fear of making a mistake or missing out on gains. By the time they feel “sure,” the market may have already priced in the growth, leaving little room for further immediate upside. Research in behavioural finance highlights this tendency and its impact on investment outcomes.
- Herd Mentality
- Investors often follow others when they see rising prices, thinking it’s a sign of safety. This can lead to mass investing near market peaks when optimism is highest, increasing the likelihood of a subsequent correction.
- Recency Bias
- People give undue weight to recent performance. When a stock or fund has been performing well, it feels like a “safe” investment; and people ignore the risk rating. Many risk-averse investors are seen investing in small-caps AFTER they run up substantially.
- Fear of Loss (Risk Aversion)
- Investors are hesitant to invest when markets are uncertain or volatile, waiting for signs of stability. Unfortunately, by the time they act, much of the growth potential may already have materialized.
B. Market Timing Bias
- Markets are inherently volatile, and short-term fluctuations are normal. If you invest during a market peak or when valuations are high, a correction might follow, making it appear as if your investment caused the decline.
C. Mean Reversion
- Momentum often drives stocks or funds up in the short term, but mean reversion (returning to average performance) often kicks in over the medium term. Investors chasing momentum may term this statically normal phenomenon as ‘underperformance soon after investing’
D. Profit-Taking by others
- When stocks rise too quickly, profit-taking by investors can trigger a decline. Institutional investors, for example, frequently rebalance portfolios, selling overvalued assets and buying undervalued ones. And since their portfolios are large, it often leads to a decline.
How to avoid/ handle this phenomenon:
- Invest Based on Fundamentals
Focus on the intrinsic value of an asset rather than recent performance or trends. Evaluate mutual funds or stocks using metrics like valuation, earnings growth, or sector outlook.
- Use Systematic Investment Plans (SIPs)
Instead of investing a lump sum, SIPs allow you to invest periodically, reducing the impact of market volatility.
- Research and Diversify
Avoid relying solely on past performance. Also, spread your investments across asset classes, sectors, and geographies to reduce the impact of poor timing in one area
- Stick to Your Investment Plan
Align investments with your goals and risk tolerance. Avoid reacting emotionally to short-term changes.
- Avoid the temptation of ‘Timing the Market’
It’s almost impossible to predict the perfect time to invest. Instead, focus on staying invested and consistent.
Over time, disciplined and informed investing will help you ride out these short-term “dips” and achieve your financial objectives.
Paraphrasing Jack Bogle, I will conclude by saying to investors: ‘volatility is your friend, impulse of your enemy'(The article is attributed to Sandeep Walunj, Group CMO, Motilal Oswal Financial Services Ltd.)
