Investor Corner/Building and judging a portfolio/Portfolio Construction & Behaviour
3.1.11 Behavioural Biases
Behavioural biases such as loss aversion, recency bias and herd mentality quietly shape investment decisions. For most investors, these biases cause more damage to long-term returns than poor fund selection ever does.
A few biases worth knowing by name
Loss aversion is the tendency to feel the pain of a loss more sharply than the pleasure of an equivalent gain, which pushes many investors to sell at exactly the wrong moment during a downturn. Recency bias is the tendency to overweight recent events and assume they will continue, which drives chasing whatever has performed best lately. Herd mentality is following the crowd into or out of an investment simply because everyone else appears to be doing so.
Why these biases are expensive
Studies comparing the return an average fund earned against the return its average investor actually earned consistently find a meaningful gap, and that gap is largely attributable to poorly timed buying and selling driven by exactly these biases, rather than to picking bad funds in the first place. The fund itself often performed reasonably well; the investor's own timing decisions are frequently what fell short.
Practical defences against your own biases
Automating investments through SIPs removes many timing decisions from active, in the moment judgment. Writing down an investment plan and its underlying reasoning in advance, before any crisis hits, gives something concrete to refer back to when emotions are running high. Limiting how often you check portfolio value can also reduce the number of opportunities for these biases to actually influence a decision.
How PriLytics helps. PriLytics shows your real XIRR based on exactly when your money actually moved, so the gap between fund performance and your own timing decisions is visible rather than hidden. See how returns are calculated.