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Sam Ghosh Founder and SEBI Regd. Investment Adviser at Wisejay Private Limited Bangalore, Karnataka
What is Availability Bias and why you may not be taking best financial decisions?
1 answer/comment
08:59:49 AM, 27th February, 2019
  • Sam GhoshFounder and SEBI Regd. Investment Adviser at Wisejay Private LimitedBangalore, Karnataka
    Profile

    What causes more deaths in India among the following? –

    Road Accidents, Influenza/Pneumonia and Low Birth Weight?


    Most people will immediately think that road accidents cost more lives than seemingly rare deaths by influenza/pneumonia or low birth weight.

    The reality is very different. According to data gathered from various sources, the number of death in India caused by Influenza and Pneumonia and Low Birth Weight is more than twice and 18% more respectively than the deaths caused by road accidents.


    Then why the fatalities by road accidents seem to be much more common than influenza or low birth weight? Because we do not hear about them enough. News of road accidents is much more likely to spread through organised channels (such as newspaper or television) and word of mouth than deaths caused by influenza. So, our impressions are formed by the availability of information. This is called the Availability Bias.




    Now, think for a moment – What is the source of the information or advice based on which you take your financial planning and investment decisions?

    Apart from regulatory sources (which are often written in a language too complex to common people) most information and advice people receive are from people who are selling the financial products. There is nothing wrong about informing investors about financial products but investors must understand that the advice is NOT FREE. Even with the best intentions, free advice may become a sales pitch when the incentives are not aligned with the investor and product distributor.

    Most financial products in India are sold on the basis of commission i.e. the advice is not free but paid by you in form of increased expense ratios or deducted from payments by the clients. One may think that it does not matter because the commission is often too small. Yes, in the short term it may not matter. But, let us see the effects in the long term.

    Consider your portfolio is expected to return 12% in the long term. Now, due to the commission, you effectively get an 11% return i.e. 1% less. Consider Rs. 100 investment for 30 years. At a 12% return, the value of the portfolio will be Rs. 2996 and at 11% the value will be Rs. 2289 i.e. ~24% less. This is just the effect of a 1% reduction in return due to the commissions. This is the compounding effect. I have no intention to depict commission as evil but an investor must understand the true impact of the commission they are paying, often indirectly. Rational investors will try to maximise the returns after all explicit and implicit costs and the commissions are often too implicit i.e. not visible to the investors.

    The above calculations do not consider the effects of bad investment advice. You may often receive free investment recommendations. Unfortunately, often the advice may not be based on suitability with your situation and requirements but the commission offered to the receommender– which can be a major source of conflict of interest and loss for you.




    The point of this post is to

    1. Encourage investors to realise the difference between Popularity and Suitability. We often correlate popularity with quality – which may not be the case. Especially in the context of financial decisions, quality is personal i.e. what is the best investment for your friend may not be for you.

    2. Encourage investors to realise that some free advice may cost you much more. Always think about the conflicts of interest.

    3. Encourage investors to actively seek advice from experts rather than passively waiting for information to come to them. Remember, the information which automatically comes to you, without you seeking, often just triggers for you to make bad financial decisions. This kind of information/advice often is not designed for your best interest.



    Related link
    https://www.worldlifeexpectancy.com/world-rankings-total-deaths

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