Reversion to mean
In the series of 21 behavioral biases we will discuss the 7th
bias “Reversion to mean”
Reversion to mean as commonly known as “regression to mean”
or “mean reversion”
This is a statistical tool which helps in data inferences
and is widely known phenomenon.
Pendulum movement is an example.
Still, let’s take an example – Cricket is favorite sport of
Indians and let’s talk about that!!
We expect Dhoni, Virat and Shikhar to score a century in
every match or show up a match winning performance. How many times do they do?
Statistical analysis of their past data shows they will perform average of
their own past averages. We troll them for poor performance and praise them for
great performance. Does Punishment or rewards leads to performance improvement?
Yes and No. Yes, it may improve it for next
few matches. No, as it will revert to his mean performance with, may be,
little better average.
Reversion to mean is ignored by most Investors. Not only
Investors but even by Business owners/ Industrialists!
Till 2008, when India was growing at fastest pace, many
industrialists announced capacity expansion plans and invested heavily. Since
then and till today most industries are suffering from excess capacity and are
debt ridden. Many established business families have gone bankrupt!! Builders
also thought the same and leveraged and announced real estate project, one
after another. You know what situation they are in today!!
Industries and builders thought that the robust demand and
growth will only accelerate. They missed the phenomenon of reversion to mean!!
India is facing the same situation today, after good growth
for many years, (and with few lose ends of reckless credit, corruption, policy
paralysis etc of past) is slowing down considerably. It will have to revert to
its mean performance of real GDP growth of 10-12% sooner or later. With stable
global outlook, it should happen sooner.
I come across many investors who are victim of the same and
ask me:
1)
Which is best performing scheme?
2)
Why our scheme is not in top quartile?
3)
Market is in bear grip so let’s not invest now
4)
So much blood bath, lets invest in safe products
now
5)
I will invest when market is going up.
We at Wealthcare Investments, believe in valuation more than other factors like
liquidity, foreign flows etc. We do not put too much emphasis on best
performing funds/sector of last 1 or 2 yrs. There are enough data to prove that
best performing fund of last 1 or 2 yrs are not in list in next 2-3 yrs. In
fact some are found in third and fourth quartile too!!
We do pay attention to something else beyond that –
Consistency of performance, long performance history of scheme (including fund
manager and the fund house), future investment outlook and Asset allocation
(tactical and fundamental).
So Investors do get succumbed to “recency bias”(if you have
missed it, read my blog on same https://wealthcarein.blogspot.com/2019/08/recency-and-primacy-effect-in-series-of.html)
The belief in reversion to mean makes one cognizant of fact
that he/she should know when to buy and when to sell. Often investor invests in
Mutual fund schemes when they are at peak of performance and sell them when
they are at bottom of performance. End result- huge loss of capital. Such investors
repeats the same error and eventually never return to Mutual fund or equity
investing.
What should you do?
1)
Study the stock market data closely and try to
understand which stage of cycle the market is? If you can’t, engage with an advisor.
2)
Need not pay attention to articles or
recommendation of best performing scheme/stock of last year. “Winner of the year syndrome is best to be
avoided”
3)
Check the attributes of the Mutual fund scheme
as to why it gave good return in last 1 year and will it be position to give
better return in near future too?
4)
Check if the market is overvalued or undervalued
with reference to future outlook and not current situation only.
5)
Examine if being contra investor helps by
ignoring current hypes.
MF Trivia: Any long term Investment goals like kids
marriage, retirement corpus another house etc. can be planned with Mutual Funds
also. You need not have to invest in Insurance policies (with those specific
names like child education or retirement plan) only.
This article
is written by Bhavesh D Damania founder of Wealthcare Investments.
You can
reach him at 9833778887 and wealthcarein@gmail.com
"Risk comes until you know what, where and why you are
Investing"
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