Have you ever wondered why we sometimes make decisions that seem counterintuitive? Choices driven by fear or influenced by popularity rather than rationality?
If so, you're not alone. Our brains are wired to make decisions based on shortcuts, which can lead to biases. In my previous blog, we explored the effects of recency bias and framing bias on decision making.
In this blog, we will explore availability bias, its effects on real-life and investing, and provide strategies to overcome it.
Availability Bias: What you see is all there is
As human beings, we rely on our past experiences and memories to make decisions in the present. However, sometimes our memories can be flawed, leading us to make decisions based on incomplete or inaccurate information. This is known as availability bias, which occurs when people make decisions based on information that is easily available to them, rather than seeking all possible information before making a decision.
One example of availability bias is the influence of media coverage on people's perceptions of crime rates. Media outlets tend to focus on sensational or violent crimes, which can create the impression that such crimes are more common than they actually are. This biased perception can influence our attitudes, behaviour’s, and even shape public opinion on important issues related to crime and safety.
“People tend to assess the relative importance of issues by the ease with which they are retrieved from memory—and this is largely determined by the extent of coverage in the media"
—Daniel Kahneman, Thinking Fast and Slow
In investing world as well, we frequently rely on information that is readily available or that we are most familiar with, even if it may not be the most rational approach. Let me share an example that illustrates how availability bias can influence investment decisions.
Consider this case of my friend who had invested ₹1,00,000 in equities in January 2020. Unfortunately, the COVID-19 pandemic hit shortly after, causing a steep market crash of ~40%. As a result, value of his investments dropped to ₹60,000. Fearing further losses, he exited equities and invested his money in a fixed deposit at 6%. The lasting memory of that crash made him fearful, and he refrained from re-entering the equity market, showcasing availability bias in action.
Now, let’s fast forward to 31st May, 2023. If my friend had stayed invested in equities, he would have not only recovered his initial investment but also earned an additional ₹56,000 in gains. In contrast, his decision to stay out of the equity market and opt for a fixed deposit resulted in a loss of ₹26,000 (after accounting for the interest income earned from the fixed deposit).
Diversifying Investment Choices: Moving Beyond the Familiar
In another example, on a crowded train in Mumbai, I struck up a conversation with a fellow passenger about my profession. To my surprise, he believed that only Nifty 50 and SENSEX-based index funds existed. Sensing his limited perspective, I seized the opportunity to expand his understanding. I explained how index fund investing offers a wide array of investment options, serving as the foundation for a robust and diversified investment portfolio.
I introduced him to the Nifty 500 index fund, which provides a comprehensive view of the Indian equity market by tracking the top 500 companies listed on the NSE. Additionally, I emphasised the availability of other types of index funds, such as broad-based, factor-based, international, sectoral, and debt index funds. Each of these options offers simplified investment solutions tailored to cater to various investor preferences and goals.
How to overcome availability bias?
To overcome availability bias and make more informed decisions, it is essential to adopt a mindful and deliberate approach to information gathering and analysis. Consider adopting the following strategies:
· Diversify your information sources: Seek information from a variety of sources, including financial advisors, research reports, and expert opinions. Avoid relying solely on easily accessible or widely publicised information.
· Maintain a decision journal: Keep a record of your investment decisions, documenting the reasoning behind them. Regularly reviewing your decisions enables you to identify instances where availability bias may have influenced your thinking. This awareness empowers you to make adjustments and improve your decision-making process.
· Take a systematic approach: Develop a disciplined investment strategy based on objective criteria and long-term goals. Stick to your strategy even when recent events or easily available information might tempt you to deviate.
Additionally, engaging the services of a financial advisor can be invaluable in overcoming availability bias. A knowledgeable advisor can provide you with a broader perspective, unbiased insights, and personalised guidance tailored to your financial goals. Their expertise can help you navigate through the noise and make informed investment decisions.
In conclusion, understanding and addressing behavioural biases, such as availability bias, is crucial for making informed decisions in various aspects of life, including investing. Availability bias can limit our perspectives, restrict our understanding of investment options, and potentially hinder our wealth creation journey. By recognizing this bias and adopting strategies to overcome it, one can navigate the investment landscape effectively. By being mindful of our biases, we can become more astute investors and lead ourselves towards a path of financial success.
Mahavir Kaswa is Head-Research of Passive Funds, Motilal Oswal Asset Management.