What’s in the blog?
This blog explores how anchoring bias i.e. fixating on past performance can mislead mutual fund investors. It explains why relying too much on historical returns might cloud your judgement and offers practical tips to stay objective when choosing funds.
Table of Contents
I’ve noticed a pattern of investors wanting to put their money in small-cap funds because, obviously, small-cap funds have been generating good returns for approximately four years now. While the undertone talks among fund managers indicate a movement away from small-cap funds, many retail investors remain fixated on past performance. Experiences like this are very interesting and teach so much about how behavioral biases influence investment decisions.
This tendency isn’t random—it’s rooted in a well-known psychological trap called anchoring bias.
Investors anchor their expectations on past performance, assuming that strong historical returns guarantee future success. However, just like driving a car, you can’t rely solely on the rearview mirror; past performance is one data point, not the entire roadmap.
In this blog, let’s explore how anchoring bias affects mutual fund selection and how to make better investment decisions based on a holistic approach.
What is Anchoring Bias?
Anchoring bias is a cognitive shortcut where individuals rely too heavily on the first piece of information they receive—such as past returns—when making decisions. In the context of mutual funds, investors often anchor their expectations on historical performance, assuming that high past returns will continue in the future.
But markets are dynamic. Economic conditions, interest rates, and sectoral shifts impact performance, making past data a poor predictor of future results. Think of it like driving a car—you glance at the rearview mirror for context, but you can’t drive by looking only at it. Past performance is just one parameter among many, not the entire picture.
Why do Investors fall for it?
As humans, we are wired to develop biases—it’s an evolutionary hack that helps us navigate uncertainty. In the financial world, this bias manifests when:
- Investors see a fund that has consistently outperformed and assume it will continue to do so.
- Marketing materials highlight past returns, reinforcing the illusion of reliability.
- Investors hesitate to sell underperforming funds, expecting a ‘return to glory’ based on past trends.
How to Avoid Anchoring Bias in Mutual Fund Selection
To make objective investment decisions, investors should:
Look Beyond Past Returns
While historical data provides context, focus on other fundamental factors like expense ratio, fund manager expertise, sector allocation, and risk-adjusted returns.
Educate Yourself on Personal Finance
The more you understand the methodology behind fund selection, the less likely you are to rely on superficial indicators.
Focus on Financial Goals
A fund that performed well in the past may not align with your current risk appetite or financial objectives.
Understand Market Cycles
Different market conditions favor different types of funds. Study macroeconomic trends rather than fixating on past returns.
Diversify Your Portfolio
Instead of betting heavily on one fund based on past success, spread investments across asset classes to mitigate risks.
Take the Help of an Expert
Finance experts can help you pick funds that align with your risk appetite, and short-term and long-term goals. They have been in the market and understand its hacks.
My Take
Personal finance is only 20% about the numbers. The rest 80% is about managing emotions and behavior. The ability to recognize and mitigate biases like anchoring can significantly improve investment outcomes. By adopting a disciplined, research-driven approach, investors can make better decisions that align with long-term financial success.
If you need any help getting over your biases and taking logical control of your personal finance, team MoneyAnna is just a message away. Reach out or drop your message in the comment section below.
