A pragmatic case study on Behavioral Finance

Author:

Anup Kumar Ghosh

Professor of Management, Disha Educational Society, Raipur, India, email: anup.ghosh@dishamail.com

Madan Mohan Dutta

Faculty, Department of Management , J.D. Birla Institute of Management, Kolkata, India,email: mmd_248@yahoo.co.in

Malher Majumder

Director, Bliese Consulting Pvt. Ltd. & Member Faculty-Dun & Bradstreet India Pvt. Ltd. , Kolkata, India, email: malhar@bliese.in

A pragmatic case study on Behavioral Finance

INTRODUCTION

What do we do with our money?

Why do we do so?The information bombardment impacts human mind and touch upon a number of mental shortcuts (judgmental heuristics). The sensory organ of an average human being receives around 2.4 billion bits of information every minute. There is no indication that this massive inflow of information (good or garbage) -will subside: however what will differentiate mature men from kids, will be an ability to quickly process the information, reach a conclusion and take efficient action in a time bound manner.

Rationale of the studyIn India, the growth rate of individual investment is 23% as observed by RBI. But the decision taken by the investors are quiet dubious as they are doing it through any mental shortcut or after proper study / through proper decision making procedure. Without the same, there is a chance of incorrect investment decision or lower rate of return.

Objective of the studyIn this study, the researchers tried to find out different Judgemental Heuristics or Mental Shortcuts that the investors usually take during investment decisions. The objectives are :•To understand the guiding areas of behavior of an investor before taking any decision.

•To study the psychological gamut of the investor.

•To highlight the areas which require proper attention by the financial planners.

•To sketch a rough outline for the investors before taking a wise decision.

MethodologyThe investors of West Bengal and Orissa have been taken into consideration in this study as a pilot survey. A structured interview schedule was administered to investors through web based survey. Altogether 327 respondents have submitted their feedback against the structured questionnaire sent through mail to 1000 investors, collected from different financial planner’s clientele. Besides, other important data have been collected from journals, books, reports and conference proceedings. This study was conducted during May 2010 to September 2010.

Methodology

The data, so collected, were processed through computer (MS-Excel). The processed data have been converted into different tables to find out the decision behavior pattern of the sample group investors.

Percentage and Ranking were also done to portray different mental shortcuts.

AnalysisInvestment decision taken from past experience 238 72.78%

Investment decision taken as new risk 89 27.22%

Total 327 100%

This particular table shows that most of the investor in the sample group are not very much aggressive to take any new decision. During the course of the experiment it has been observed that while the second group made investment in their choice instruments, the first group showed a remarkable bias to hold the instrument, they already possess. This particular syndrome is being called as status quo bias. These biases are often followed by complete inaction on the part of client: referred to as the decision paralysis syndrome.

AnalysisB

•Investment done from the money I have earned beyond my plan 184

•Investment done with previously defined plan 143

•TOTAL 327

C

•Reinvest in the same fund 299

•Take decision to invest in other venture from the interest accrued from previous investment 28

•TOTAL 327

D

•Withdraw the funds where it is in losing position 287

•Wait till the fund reaches a gaining position 40

327

Analysis

YES NO

EFORMAL EDUCATION ON INVESTMENT ANALISYS 2 325 327

FREGULAR PARTICIPATION IN

INVESTMENT ANALYSIS 33 294 327

GKNOWLEDGE ON STATISTICAL

ANALISYS OF FUND 41 286 327

H

OTHER THAN PRESENT SHARE VALUE ANY OTHER INFORMATION IS

BEING COLLECTED REGULARLY 45 282 327

IREGULAR YEARLY PLANNING FOR

INVESTMENT 22 305 327

Analysis

JFUND / OPTION CHOICE DECISION TAKEN IN CONSULTATION WITH

SELF51

FRIENDS129

FAMILY MEMBERS74

INVESTMENT PLANNER48

AGENT/BROKER25

Total327

DiscussionThe reflection of investor’s behavior for maintaining the own fund is at ‘C’. This particular decision behavior is known as Endowment Effect. The Endowment effect is a hypothesis that people value an item more, once their property right on it is established. In other words, people tend to place a higher price on object, they own relative to object they do not.

The answer as received against question ‘D’ is a syndrome known as Regret avoidance. It is the tendency to avoid actions that could create discomfort over prior decisions, even though those actions may be in the individual’s best interest.

Discussion

The reflection of the answer for ‘J’ validates another mental shortcut referred as Overconfidence. This particular trait in human nature called familiarity. Familiarity brings with it a herd mentality, where investor takes a position simply because some one he knows have done it.

It is crystal clear from the answers as received against section ‘E-I’ that a very few investors are interested in having knowledge of investment rather they are more prone to follow mental shortcuts.

Conclusion

The financial planers should have to take the role of Financial Physicians: Ask, listen, educate and diagnose their problems as a physician does.

There is a prime need include behavioral syndromes in the overall Financial Planning process.

ConclusionFinancial Planners who act as financial physicians combine the science of finance and securities with the ability to empathize with and guide clients - thinking not only about statistical risk and return as propagated in traditional investment models but about investors’ individuality, characterized by their fear, love, greed, aspiration and mistakes, which in reality exists in human nature.

Scope for further studyThis particular study may be conducted for the investors of other states to conclude a general behavioral pattern.

Some other syndromes like Mental Accounting, Representative bias etc., may be studied.

The questionnaire may be further extended to identify other psychological factors and relation thereto with investment decisions.