Chapter 19

19Behavioural Finance

Behavioural finance studies how investors damage their own plans. This chapter follows the emotional sequence: greed, fear, panic selling, FOMO, herd mentality, overconfidence, and daily portfolio checking.

Greed

Example: in a rising small-cap market, investors may increase allocation just because neighbors made money. Greed replaces expected return with entitlement and usually ignores downside.

It appears strongest after recent gains and pushes investors toward leverage, concentration, and products they do not understand.

Respect downside.

• Treat unusually high promised return as a risk signal.
• Keep allocation limits even in bull markets.
• Ask what can go wrong before investing.

Fear

Example: after a sudden market fall, the same investor who wanted high returns may want to exit everything. Fear compresses time horizon exactly when patience is most valuable.

Fear is useful when it detects real danger and harmful when it forces irrational exit. Markets exploit unprepared fear through volatility.

Prepare before decline.

• Expect declines before they happen.
• Hold only the equity level you can survive.
• Do not sell long-term assets only because prices fell.

Panic selling

Example: selling equity funds during a crash converts temporary price decline into permanent capital loss. Panic selling is usually a liquidity or temperament failure, not an investment strategy.

It converts temporary price decline into permanent loss. It usually happens when risk was misunderstood before investing.

FOMO

Example: when IPOs, crypto-like themes, or hot sectors dominate conversation, investors may buy only to avoid feeling left out. FOMO makes someone else's return the basis for your risk.

It mistakes observed motion for future certainty. By the time a theme is socially obvious, risk may already be priced badly.

Accept missed gains.

• Do not buy because everyone is discussing it.
• Compare every new idea with your written allocation.
• Accept that missing some gains is part of discipline.

Herd mentality

Example: if everyone in an office buys the same thematic fund after one strong year, the crowd may already have moved the price. Herding feels safe socially but can be dangerous financially.

Demand independent reason.

• Demand independent reason for every investment.
• Avoid crowded products without understanding valuation and risk.
• Use rules when crowd emotion is loud.

Overconfidence

Example: a few profitable trades can convince an investor that skill is higher than it is. Overconfidence increases position size before the process has been tested across bad markets.

It often follows lucky gains. In markets, a small sample can look like proof while being statistical noise.

Use position limits.

• Track decisions and outcomes honestly.
• Limit position size when uncertain.
• Prefer boring diversification unless you have real edge.

Checking portfolio daily

Example: daily app checking makes long-term capital feel like a scoreboard. The more often the investor observes noise, the more likely they are to act on noise.

Daily checking increases emotional sampling. More observations create more chances to see loss, even when long-term probability is acceptable.

Reduce noise.

• Review long-term portfolio monthly or quarterly, not daily.
• Check goal progress annually.
• Remove apps or alerts that trigger impulsive action.