This is WHO Investors First Need Protection From

Amar Pandit , CFA , CFP

October 1, 2024 | 5 Minute Read

On a recent trip to Pune, I noticed that most motorcycle riders weren’t wearing helmets. My colleague Rupesh remarked, “Most bikers here don’t believe in wearing one. Some have even protested against it. In fact, there have been strikes by bikers against wearing a helmet.” At first, I thought he was joking; I couldn’t imagine people opposing something so crucial to their safety. But as I thought more about it, I realized it wasn’t just about helmets. It’s a reflection of how, in many areas of life—whether it’s smoking or investing—we often act against our own best interests.

So, who do we really need to be protected from?

To answer this, let me share an interesting data point from a study by SEBI that analyzed data from 144 IPOs. The findings were fascinating, but also alarming. The study revealed that shares allotted to retail investors were often sold within a week. This rapid selling, commonly known as “flipping,” is highly prevalent among individual investors. It’s not just this. Most investors lost money while doing this.

If investors are so quick to sell, what does that tell us about their behavior? And more importantly, who do they need to be protected from? The answer, quite simply, is themselves.

As investors, we are often our own worst enemies. It’s not market volatility or global events that cause the most damage. Instead, it’s our own emotions, behavior, biases, blind spots, and poor decision-making.

The Problem of Investor Behavior

Let’s start by acknowledging a simple truth: human behavior is irrational, especially when it comes to money.

Why would anyone sell a stock in a week, especially one they fought to get in a highly competitive IPO? The reason is rooted in emotions and short-term thinking. When we see a small profit, we want to lock it in, fearing that the gains might disappear. The result? Investors often sell too early, missing out on long-term growth opportunities.

This is a classic example of how emotions drive poor decisions. Fear and greed—two powerful emotions—can wreak havoc on even the most carefully thought-out investment plans.

The Dangers of Flipping

Flipping IPO shares is just one manifestation of the larger issue: investors’ need for immediate gratification. It’s human nature to want quick rewards. When the shares go up, there’s an urge to sell quickly, pocketing the gains. This short-term mindset can have detrimental long-term effects.

Investors who engage in flipping miss out on the potential growth of the company. They see the quick gains but overlook the possibility of compounding returns over time. Essentially, flipping focuses on immediate, short-term wins at the expense of building wealth over the long term.

Another study by SEBI found out that 93% of F&O traders lost money. Some 1.13 Crore retail F&O traders incurred a combined net loss of Rs.181,000 Crore over the last three financial years of FY22-24.

By the way this is not limited to novices only…Professional investors as well as high net-worth investors including family offices lose money by acting against their own interests. This happens in many ways and it’s the subject of one of my future posts.

Who Should We Then Protect Investors From?

If you’re still wondering who investors need protection from, the most critical answer is: themselves.

We like to think that the market is our enemy, or perhaps the financial industry is out to get us. But in reality, it’s our own biases, assumptions, and behavior that pose the most significant threat to our financial well-being.

The Psychological Traps of Investing

 

Money isn’t just numbers on a screen; it’s deeply tied to our feelings. Whether it’s fear, greed, or the security that wealth brings, emotions play a central role in how we handle our finances. The way we feel about money can drive us to make decisions that may seem irrational in hindsight. And when we let emotions take control, we often overlook the fundamentals, acting out of fear of loss or the joy of immediate gain.

As investors, we fall prey to various psychological traps that affect our decisions. These include:

1. Confirmation Bias:
We tend to seek out information that confirms our existing beliefs while ignoring evidence that contradicts them. If you believe a particular stock is great, you’ll likely find reasons to back that belief, even if the data suggests otherwise.

2. Overconfidence:
Many investors are overconfident in their ability to time the market or pick the right stocks. This leads to taking excessive risks.

3. Loss Aversion:
Psychologically, the pain of losing money is far greater than the joy of making money. This leads investors to make irrational decisions, like selling winners too early or holding onto losers in the hope of breaking even.

4. Herd Mentality:
When everyone around you is buying or selling, it’s hard not to follow the crowd. This herd mentality leads to poor timing and often ends in buying high and selling low.

5. Recency Bias:
We place too much weight on recent events or trends and assume they will continue indefinitely. If a stock has been rising, we assume it will keep rising, and if the market has been volatile, we assume it will stay that way.

Protecting Yourself from Yourself

Given these psychological pitfalls, how can investors protect themselves from their own poor decisions? Here are a few strategies:

1. Focus on Long-Term Goals:
Investing is not about making quick gains. It’s about building wealth over time. Keep your long-term goals front and center. When you’re tempted to flip a stock for a short-term gain, ask yourself how this decision aligns with your broader financial objectives.

2. Set a Plan—and Stick to It:
Having a clear investment plan can help you avoid impulsive decisions. Your plan should outline your risk tolerance, asset allocation, and long-term goals. When the market gets volatile or you feel the urge to act based on emotion, refer back to your plan.

3. Control Your Emotions:
Recognize that investing is emotional, but successful investing requires managing those emotions. When you feel fear, remind yourself that markets are cyclical, and downturns are a part of investing. When you feel greedy, remember that quick gains are often followed by losses.

4. Automate Decisions Where Possible:
One way to remove emotion from your investment decisions is by automating them. Set up a systematic investment plan (SIP) or use rebalancing based on set timelines. Automation takes emotion out of the equation, forcing you to stick to your strategy.

5. Diversify Your Portfolio:
Diversification helps spread risk and reduce the temptation to make dramatic moves based on the performance of a single asset. When you have a well-diversified portfolio, you’re less likely to panic and flip investments when things go south.

6. Seek Professional Counsel:
Sometimes, it’s helpful to have an objective third party to guide your investment decisions. A real financial professional can provide a clear perspective, free from the emotional bias that often clouds judgment.

The Importance of Patience

Investing requires patience. True wealth is built over decades, not days. The most successful investors are those who can weather short-term volatility and remain focused on long-term goals.

Warren Buffett famously said, “The stock market is designed to transfer money from the Active to the Patient.” It’s the patient investors—those who resist the urge to flip, sell, or panic—who see the greatest long-term rewards.

Patience allows your investments to compound over time. Compounding is one of the most powerful forces in investing. The longer you stay invested, the more your money grows, and the growth becomes exponential over time.

Protecting Your Future

At the end of the day, the person who can make or break your financial future is you. While market crashes, recessions, or IPO flipping may seem like external threats, the real risk lies in how you respond to these events.

Investors need to be protected not from the markets, but from their own behavior. The key to long-term success is managing your emotions, avoiding psychological traps, and maintaining discipline in the face of uncertainty.

Remember, investing is not about avoiding risk altogether. It’s about managing that risk intelligently and staying committed to your long-term goals. Don’t let short-term thinking, emotional reactions, or biases derail your financial future.

As SEBI’s study shows, many investors are quick to act, often to their detriment. The real protection you need isn’t from market volatility or IPO hype or from F&O. It’s from your own instincts, your own biases, and your own behavior.

The next time you’re tempted to flip an investment or react impulsively to market news, take a step back. Remember that successful investing is about patience, discipline, and long-term thinking. In the end, the greatest risk is not the market itself, but how you behave in it. Protect yourself—from yourself.