Let us accept some facts early on:

There are more bankruptcies than billionaires…

We do not have any data about Indian investors, but MORE than agree with Sucheta Dalal and Moneylife that the number of investors have dwindled. This is terrible for the economy, but clearly a regulatory failure.

Since we do not know by what margin Indian retail investors are under performing the indices, let us assume it is huge – like the US.

Why does this under performance happen? It happens because of BIAS.  We are impacted by many biases..let me try to talk about a few.

1. Recency bias: “The market did well in 2012, so it will do well in 2013”. Is a very easy (and wrong) conclusion to arrive at.  Actually there is nothing from the past data to help us be sure about market performance in the future. We may have gone wrong in the past, but we are still OVERCONFIDENT of our ability to predict the immediate future based on the immediate past.

if the index went up 7 times from 2002 to 2007, it should HAVE gone up from 2008 to 2013? so it should be 147,000? Well, well, we do believe it..

2. Confirmatory bias: we ONLY like data which we WANT to see. Sadly the eye sees ONLY what the brain wants us to see. So when I get good news about Colgate, Gillette, PnG, ITC, Hdfc – I devour it, but when I get news against them I ignore or say ‘oh the media does not know anything’.

3. Loving what we already have: If there is Coromandel International already in my portfolio and it has given me a fantastic 70% CAGR over a 10 year period, it will take 15 horses to pull me away from this share. The love makes it difficult to sell. I SOLD coro only because I had to buy Cholamandalam and later on Shanti gears  – the switch was damn damn profitable, but it still is difficult to sell WINNERS.

4. Control bias: Thinking that we can predict the future, or feeling we UNDERSTAND the company, the economy, mass investing psychology,…fascinating how we fool ourselves EVERYDAY. INSPITE of knowing that we do not. This in philosophy is called ‘MAYA’.

5. Risk perception: Most people in the world (Indians more perhaps) think equity market is risky. So they invest in fixed income securities – completely indifferent to the HUGE risk of Inflation. This is ‘risk perception’ bias. They THINK THEY UNDERSTAND RISK.

6. Averaging / throwing good money after bad money: ‘How can I be wrong’ – again an EGO bias. I know people who ‘averaged’ Reliance Power and Reliance Communication. Even averaging in Reliance Industries hurt, did it not? Averaging works ONLY in a portfolio – so if you average do a SIP in a mutual fund, or in the indices like sensex or nifty. If you do direct equity, remember to take losses and SELL if the market is telling you you are wrong.

…more to follow hopefully…