For mutual fund investors, the biggest risk is within — their behavioural biases
The popularity of mutual funds has soared in the past decade or so in India, with over Rs 38 lakh crore in assets under management (AUM), more than 11 crore folios — including nearly 5 crore systematic investment plan or SIP accounts — and over 7% share of household financial assets1 at the latest count.
That being said, investors need to keep in mind that mutual funds are capital market-driven and therefore behave differently from traditional instruments such as fixed deposits. They also involve different risks — including unknown ones, which manifest due to our own behavioural biases — that need to be considered before getting into these instruments.
The many behavioural biases…
Investors think and act based on their personality traits and emotional state, also termed as behavioural biases. These factors complicate the investment decision making process and defy logical reasoning.
We have seen how investors have succumbed to behavioural biases during the 2008 global financial crisis, and then in 2018 as the domestic credit crisis played out.
Many investors, who had entered the equity markets in droves before 2008, rushed for the exit following a sharp, swift spiral in stock prices. Herd mentality, loss aversion, and recency bias all played their part. In fact, the experience held back investors even when stabilisation of the financial system translated into a recovery in equity markets because of anchoring bias.
A similar saga played out in 2018, but this time in the credit risk fund category within debt mutual funds, post default by Infrastructure Leasing & Financial Services (IL&FS). Investors who had entered the category to benefit from higher yields had not factored in risks associated with investments in lower rated papers thus getting impacted by the downgrades, defaults and the subsequent impact on capital invested.
The event saw investors paint all debt funds, or for that all fund categories, with the same brush. This single lens approach can be disastrous to financial planning.
1 Reserve Bank of India, Association of Mutual Funds in India
