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Investment Tips

Understanding Investment Bias: What influences investors’ decisions?

The benefit of behavioural finance is that investors are able to recognize these behavioural biases and take corrective actions to avoid financial losses.

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When an investor buys or sells a security, is that decision based on a knowledge of all the relevant information about that asset? Probably not. Most financial decisions are made based on irrational or insufficient analysis of data, thus leading to irrationality. Irrationality is a product of our own behavioural bias.

Behavioural Finance combines behavioural and cognitive psychology theory with conventional economics and finance theories to provide explanations for why people make irrational financial decisions. The benefit of behavioural finance is that investors are able to recognize these behavioural biases and take corrective actions to avoid financial losses.

I have selected just a sample of some behavioural bias:

  1. Anchoring
  2. Herding
  3. Familiarity
  4. Trend Chasing
  5. Loss Aversion

Anchoring: An Anchor bias is any variable of information which has no direct relevance to a decision but does affect financial decision making. In essence, a bit of information becomes “anchored” in our minds and thus automates our decision making.

An anchor can establish a low price bias to encourage a purchase decision or establish a higher price to lock in future purchases on that price. For example, a phone is listed at N20,000 but the shop puts up a “10% Sale” sign beside the price, effectively “reducing the price to N18,000. The buyer, however, anchors in his mind that the phone costs N20,000 not N18,000, he assumes a N2000 “discount” and pays for it. If given a choice between this phone and a similar model costing 18,000, a buyer may select his phone believing a deal of N2,000 for a N20,000 phone.

[Read Also: Important tips on how to profit in a bearish market]

Another excellent example is when a stock priced at N50.00 falls to N20.00.  An investor, having anchored the previous N50 share price in his mind, will determine that N20 is a “cheap” price and invest in that stock.

Key lessons: Do careful intrinsic evaluations before investing. For the entrepreneur, Be careful when setting prices. If your “special” pepper-soup, for instance, is  N2,000 per plate, that’s the anchor. Customers will be wary about paying above that prices for any other dish in your restaurant.

Herding: Herding Bias is the tendency for individuals to copy and follow the actions (rational or irrational) of a larger group.

Imagine you go to a party and everyone is talking about this cryptocurrency fund they have just invested in. You are normally risk-averse, but you reason in your mind that if so many people are investing in this cryptocurrency, they all cannot be wrong. Consequently, you take comfort in the “safety” of crowds and also invest.

With herding, any form of appraisal is blurred by the tendency to follow the crowd, and not be left out of the latest investment trend.  In other words, herding diminishes analytical reasoning, and that is the danger.

Key lessons: Study each investment carefully on its own merits and always remember every investor has different levels of risk acceptance. Referrals are just that…referrals to you. Ensure you do your own due diligence all the time. If everyone speaks highly of a vendor, have your own in-house assessment to confirm if the internal process of that vendor is aligned with your organisation. Do not just hire an Insurance company because everyone in your industry uses them; have your own internal decision-making process to select vendors.

Familiarity:  Familiarity bias is when an investor has become familiar with the operations and/or returns associated with a particular asset class, develops a comfort zone around that asset class, and is then reluctant to try other asset classes even though they may offer higher returns or reduce the overall risk of the portfolio. Here is an example; an investor may only be aware of investing in two-year Corporate Bond which he rolls over continuously after earning interest. Coupon bonds become his investment comfort zone and he is reluctant to invest in a security that pays zero interest such as a zero coupon bond, even though that security with no coupon payments is less susceptible to interest rate movements, thus less risky.

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Key Lessons: Invest with a goal in mind. If your investment goal is clear and properly communicated, then follow the guidance and advise of an investment professional. Scenario planning, explore multiple options on paper, to see the effects of each action, before taking a decision.

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Trend-chasing: This is when investors look at the past performance of a security or company in order to make a decision today whether they should invest.

In the world of investing, the common maxim is “Past performance is not a guarantee of future performance”. A fund may return 40% in year 1, even as a 43% return in year 2 does not mean it will even break even in year three.

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[Read Also: Here are ways to ask family and friends to fund your business – PART 2 ]

Trend-chasing is a very common bias because investment firm will advertise their past performance to attract prospective new investors.  Even if the investment firm is honest and competent and really wants to deliver above average returns, the fact that other investment firms will copy a winning strategy means the impact of that winning strategy will be greatly diminished.

Key Lesson: When evaluating investments or investment firms, employ quantitative and non-quantitative measurements. Take past performance into account, but do not base decisions solely on that factor. Look at every investment on its merits, not its antecedents. Past performance and prices are not a sufficient indication of future performance or prices.

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Loss Aversion: Loss aversion bias is when an investor has an aversion to making or admitting they have made a loss on an investment.

Investors have a high degree of confidence in their ability to pick investments, and do not want to admit that sometimes they picked the wrong horse. The direct implication is that investors hold onto a bad investment, because selling that investment will acknowledge to themselves, they made a mistake.

For example, MMM, the failed ponzi scheme, attracted a lot of deposits. Some “investors” may have run the numbers and determined the scheme was unsustainable. Yet, they still did not exit the scheme. Another example is Bitcoin; as the prices crashed, many held on to their cryptocurrencies unwilling to admit they have bought at the peak of the curve.

[Read Also: Unilever Nigeria Plc announces close period ahead of Q3 2019 results ]

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Key Lesson: The way to avoid loss aversion is to have a clearly defined exit strategy. Be clear on what will trigger a sale from your portfolio. Also, do extensive research before investing

Summary: It is important to recognise that investors are humans and bias will always seep into all decision making; including financial decisions. The way to avoid bias, however, is to have a plan/strategy to invest and manage a portfolio, including agreeing to an asset allocation strategy and retaining a competent financial adviser.

Artificial intelligence financial programmes are also helpful in stripping away bias.

1 Comment

1 Comment

  1. Charles

    May 14, 2019 at 8:10 am

    So much enlightenment in a brief…

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Investment Tips

Retail franchise investment next gold mine for Nigerian investors- CIG

Retail franchise investment curbs unemployment  and create buffer for people looking for side hustle

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The Choice International Group (CIG) has tasked both unemployed and employed Nigerians to embrace retail franchise investment, as the initiative would curb unemployment in the nation  and create buffer for people looking for side hustle.

In line with a recent FBDS Study, there are over 450,000 Nigerian career professionals with minimum investible funds of N1 million, looking out for investment opportunities.

In the majority, these funds are looking for franchise type opportunities for ease of venturing and minimal failure risk.

As far as CIG chairperson, Diana Chen, is concerned, such investor should look no further but consider the group’s retail franchise investment opportunity, which offers Nigerian community mouth-watering offer of owning Gree & Lontor retail stores.

According to him, Gree is the world’s residential air-conditioner manufacturer, while Lontor provides high-quality, energy-saving and convenient rechargeable home appliances and lighting products for global consumers.

He said, “Both brands have been built by the CIG into a world-class electronic retail chain in Nigeria opening no less than 20 brand shops in Lagos and Oyo over the last 18 months.

“The sales performance of its existing stores in the country makes Gree & Lontor one of the most profitable businesses in Nigeria with yields of an average return on investment of 50% and above per annum.

“CIG is offering investors the opportunity to own any of six regional logistics centres, or any number of Gree & Lontor brand shops in viable locations across Nigeria.

“It is the decision of the company to open up these opportunities to the investing public through a Franchise Retail partnership.”

 

He added that the company has mapped out two investment models it says are simple, transparent, and hassle-free.

“The first model involves only six regional logistics centres located across the geopolitical zones in Nigeria.

“Whoever invests in this will require a capital outlay of $1 million, and become a mega distributor partner of the Gree & Lontor brand, and service a network of brand shops.

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“The second investment model involves the Gree & Lontor brand shops – retail franchise stores that require an initial capital outlay of N20 million.

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“The investor will secure a store size of 120-150sqm at any choice location, shopping mall, plazas, high streets and even residential neighbourhoods.”

What they are saying

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Nigeria is a growth market for franchising and franchise development services.

Gbenga Ajayi, an Entrepreneurship analyst, said, “The retail industry comes second to the food industry among sectors with best franchising opportunities.

“As with other emerging markets, one of the challenges of franchising in Nigeria remains the strengthening of intellectual-property regimes so that franchise companies can transmit knowledge and franchise system concepts with the confidence that such know-how will be protected.

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Investment Tips

Where to invest N500,000 right now

Nairametrics interviewed financial experts on what assets they would invest in if they had N500, 000

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Since a full economic recovery this year is off the table, Nairametrics interviewed some investment experts, entrepreneurs, and corporate heads, on the assets they would invest N500,000 in. The responses varied from buying gold to investing in mutual funds or starting a business.

The world economy is projected to fall by 4.4% in 2020, an upward guide from an earlier predicted rate of -4.9% made in June. The IMF projected that social distancing due to the COVID-19 pandemic will linger till 2021, but the transmission of the virus will plunge globally by the end of 2022.

Get Stock Trading Guidance Via the Nairametrics SSN Newsletter

READ: BUA Cement shows resilience to marginally improve bottom line

Temitope Busari, CFA

With fixed income yields at the current levels, my N500k in today’s market will go into a dividend-paying stock or alternative investments.

  • Depending on whether or not I can afford to risk some capital and barring timing constraints, I would buy a stock that offers periodic cashflow in form of dividends.
  • For alternative investments, I would explore high-yielding fixed deposits in the on-lending space.

READ: Thrive Agric: “Where is my money?”

Michael Nwakalor, Macroeconomist at CardinalStone Research

  • The yields in the fixed income markets are currently on the low and producing negative real returns, the equities market provides a viable alternative to earn a total return above inflation.

READ MORE: Trading and Investment for beginners: How to prepare for the stock market

  • I like stocks in the banking sector, as a number of them remain undervalued by fundamental metrics. Several names are on the course to post near double-digit dividend returns by the year-end. A portfolio that includes the following counters – GUARANTY, STANBIC, ETI, FBNH, and ZENITH, should provide adequate exposure to the sector as well.

READ: Onyema, Oniha highlight opportunities for investors in fixed income market

Adaobi Okonkwo, Currency Trader of a leading Tier 1 Bank

  • With a few things to invest in, the most reliable investment that comes to mind is a mutual fund. The fixed income and money markets are currently experiencing a downturn; hence, investing in them could reduce my income spread.
  • However, with a mutual fund, my portfolio of investment in the capital markets is determined by the fund managers with a decent return on investments certainly above the risk-free rate. Gold is a commodity that would yield a good ROI within a specified time frame if I wanted to invest by myself.

READ: FG to inject over N198 billion on capital projects in power sector in 2021

Silas OZOYA, President/CEO, SUBA Capital

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Though quite a small capital, it might not do much if you want to play the long-term investment game. However, it can set the ball rolling.

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  • I would invest it in a high yield investment platform that pays at least 5% returns monthly to cover running costs.
  • Put the money in a fixed deposit and leverage it as collateral to take a debt fund, with a 6 – 12 months moratorium from a commercial bank for a possible expansion of a profitable business. This way, you gain on the debt and still have your N500,000 intact.

(READ MORE:Nigeria’s Macro-economic dashboard for Q3 2020 – Comercio Partners)

Ugonna Thelma Ohiri-Anyanwu, CFA

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With a gift of N500,000, my risk appetite and drive for higher returns,

  • I would invest 50% of the funds (N250,000) on dollar and Eurobonds. This is mainly because of my future needs for FX and also as the need to hedge my currency risk.
  • I would invest 25% of the balance (N125,000) in Ethereum, which would give me a steady cash flow with medium risk.
  • The balance of N125,000 would be invested in Value company shares with low P/E and also stable dividend payments.

READ: CBN reveals framework for the N75 billion Youth Investment Fund

The overall investment portfolio allows for diversification, stable cash flow in both local and FX currency, and currency hedge. These would provide a solid mix between ownership of materially underpriced assets and high dividend-yielding assets.

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READ: Cryptos: Nigerian financial experts talk risks associated with trading digital assets

Bottom line

Amid the rising COVID-19 caseloads prevailing globally, the financial experts interviewed above showed significant diversity on the assets they would invest in, coupled with their different appetite for taking risk reflected on their preferred choices made amid a blurry global economy era.

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