Do we make bad financial decisions in good times?

Financial decisions are often black or white. We are either right or wrong about them.

Last year, at a mutual fund industry gathering, Deepak Parekh, chairman of HDFC, the biggest home-loan company, made a point. He said that investors tend to make bad financial decisions in good times. He attributed this to two things. Poor financial advice and the business dynamics of the mutual fund industry.

This column will focus on the ‘bad decision in good times’ theme. 

Poor financial decisions are a function of many factors. While poor advice can play a significant role, a lot of such decisions are your own doing.

It starts with the way your idea of financial well-being. For many in India, wealth is all about tangibility.

Most households in India prefer gold and real estate for investments. There is an apathy towards financial assets. Many people buy property or gold because they are tangible assets. You can see them. Financial assets are intangible. It means you cannot see them. If people buy financial assets, they do it because someone else is doing so. The herd mentality takes centre stage. During a stock market rally, they tend to buy when everyone is doing the same thing. It is most often after share prices have rallied a significant bit and near the peak. They will panic and sell when share prices tumble. 

‘There was a rift between what we should do and what we actually do,’ said Carl Richards, an American financial planner, said in his book, ‘The Behaviour Gap’. The author argues that the behaviour gap happens due to our desire to avoid pain. We are seeking pleasure that leads us to act irrationally.

The reach of financial assets in Indian households is a case in point.

Mutual funds and insurance account for a low single digit percentage of the 1.3 billion people in India. 

A RBI panel household finance survey found last year that there was a strong correlation between insurance and high-cost debt. People are not buying insurance. But they are resorting to borrowing from high-cost moneylenders in case of an emergency. This is not any institutional money and offers no protection to anyone.

The other case in point is the poor understanding of monthly budgeting, investment and risk products.

People buy expensive cars or bikes every day in India. In many situations, people own more than one vehicle. Companies are very keen to sell. As a consumer, you are very happy to take a decision to put money into something that is a depreciating asset. It is for instant gratification.

A little knowledge of finance could make a massive difference to your life. 

For example, in 2008, many of you would have bought a second Maruti Suzuki car or a new Enfield bike. If that is the only vehicle you own, it is fine. But, if this buy was made for a style statement, you may want to read further.

Something amazing happened to people who allocated a part of that extra car or bike money to two stocks.

In the 10 years to 2018, Eicher Motors shares rocketed 100 times while Maruti Suzuki zoomed 20 times. If you had invested Rs 1,00,000 in Maruti shares, your investment would have been worth Rs 20,00,000 today. The same investment in Eicher Motors would have topped a crore. No other investment can give you this kind of a return. Such companies are called multi-baggers in the stock market parlance.

Yes, this is all a hindsight. Most people do not know how stock prices or businesses would grow. Hence, eliminating bad financial decisions is next to impossible. You will continue to make them.

But, you could minimise them. The first and the foremost way is knowledge. The more you are able to arm yourself with information, the better. A professional financial advisor could be the next step. In the beginning, all the learning could be tough. But, the downside of not knowing is far more significant. 

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