Recently my wife has banned me from riding my bike. And as weird as it seems, the reason is rooted in behavioral finance. Read on to find out why..
“Bike is banned for me” – your faithfully me (a behavioral finance victim)..
A few weeks back I had written an article here on how to wrap our heads over the fuzzy concept of “risk” in investing. And I had used the analogy of riding a bike to explain my understanding of risk..
This is how it went..
“When we say a higher speed is risky, what we really mean is that if there is some unexpected external event not under your control (say a broken road, an unexpected swerve from the car in front of you, a dog suddenly crossing in front of our bike, a drunkard crossing the road etc) your ability to maneuver the bike is a lot lower at higher speeds and hence the possibility of an accident and the expected impact from it is also very high.”
As fate would have it, I met with a bike accident while on my way to office a few weeks back. Call it coincidence, it was a dog running in front of my bike and crossing the road!
I crashed into the dog which sent me flying and my bike skidding in different directions.
Since I was wearing a helmet and was at sub 40 km/hr speed the bruises were not major except for a few scratches here and there on my knees and arms.
But unfortunately I got dizzy and went unconscious twice post the accident. My worried folks had me admitted to a hospital and soon we found a doctor who was hinting possibilities ranging from a fracture, a brain concussion to an abnormal ECG reading which meant my heart might need a stent.
And of course, it scared the daylights out of me!
But as we took each and every test, the fracture, the heart issue and brain concussion were gradually ruled out. Several tears down, my wife Shalini heaved a sigh of relief. And I heaved a much bigger one.
This is definitely our most emotionally traumatic 3-4 hours ever.
Once the formalities were done and we came back home, she looked at me straight with a mix of relief and anger and shouted..
“No more bike. Ever! Bloody, start using our car!”
Mind voice of a behavioral finance victim..
Now while I completely get her point of view and I am equally scared on riding again, here is a little backdrop..
I was wearing a helmet and was going at very reasonable speeds during the accident. And thankfully, the final outcome was a few scratches which have healed now. This is exactly how we want to interpret this whole incident.
But the whole trauma of several possibilities which could have instead played out (further worsened by the inexperienced doctor) suddenly makes the whole activity of riding a bike look a lot more riskier than it actually is.
And here is the scary part – I had done a lot more crazier stuff like riding all the way to Goa, Kerala etc from Chennai with a stupid windbreaker and a cheap knee guard for protection. This included the likes of highly idiotic stuff such as high speeds on unfamiliar roads, sleepless rides, night rides in the ghats amidst pouring rain, absolutely no safety precautions blah blah. And both of us never worried about the risks then.
While I survived all this, finally, a mellowed down “on-my-way-to-office” bike ride finally got me into trouble.
As expected, we suddenly find the whole bike riding activity (a 10 km drive to my office) too risky.
Now here is the point:
All along there were times where my behavior had been really risky and yet bike riding was still fine. Now when I am a lot more matured in my riding, the sudden accident has made it look a lot more riskier than it is.
I don’t blame us as this is normal human behavior to overestimate the risk post an accident. And yes, behavioral scientists have a name for this behavioral quirk – Availability bias.
Behavioral finance has the answer..
Availability bias is a cognitive bias that lead us to overestimate the importance of information that are most available, more recent, more vivid, that were observed personally, and are more memorable.
Under the influence of this bias, we rarely check the reliability of the information we have readily available nor do we try to search for patterns beyond a time horizon that our memory can serve.
The main reason for this bias is that our lazy brain always chooses the path of least effort. In my case, accessing the fact that for 10 long years, I had thousands of rides and was pretty safe takes quite a bit of effort for our brain and hence we avoid it.
What does this have to do with investing?
Unfortunately the same bias plays out during a bear market. As we have earlier learnt, a bear market puts us under severe emotional stress (almost 2 times our pleasure during a similar upside) and most often than not, we sell out of equities and hope to get back in at the right time.
Now just like my accident, the memory of the emotional stress and market crash is fresh in our brains and it leads to us overestimating the risks in equity market.
Thus we end up staying out of equities for a far longer period as we are still fighting our “previous battle”. And normally the recovery from a bear market is damn swift and by the time we realize, we have missed a huge part of the recovery.
Check out what happened during the initial part of the market recovery from the 2008 crisis.
This mistake is not jut reserved for the average investor like us but has even happened to experienced fund managers (check the March 2009 cash holdings of equity mutual funds and you will be in for a surprise)
Availability bias spares none!
Thus, availability bias becomes our behavioral enemy no: 3 during a bear market!
Now while it’s too late to prevent my bike ban (as both of us are scared and hope we come over it in sometime), dear reader please take sufficient precaution so that you don’t get banned out of equities when the next bear market strikes.
As always in the coming weeks, we shall explore our other behavioral enemies and finally try and come up with a solution.
Till then, happy investing as always..
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Disclaimer: All blog posts are my personal views and do not reflect the views of my organization. I do not provide any investment advisory service via this blog. No content on this blog should be construed to be investment advice. You should consult a qualified financial advisor prior to making any actual investment or trading decisions. All information is a point of view, and is for educational and informational use only. The author accepts no liability for any interpretation of articles or comments on this blog being used for actual investments