Renowned financial writer and author, Jason Zweig has done an impactful experiment on investment psychology. He has taken a set of cards; 80% of them were Green and 20% were Red. The audience will have to guess the colour of the cards as he drew the cards one by one. As there were 80% green cards, people obviously guessed it Green most the time. However, in zest to get it correct, they guessed a Red being drawn after a short run of Greens. So in the end, none of them had called all the cards right.
Here is the math: the person who guesses ‘Green’ all the time will be right 80% of the time automatically. However, in attempt to guess that rare ‘Red’, they get it wrong 20% of the times and hence the accuracy drops to 64%. The audience doesn’t know in what sequence the cards are placed and in what sequence they are being drawn. With very little information available, they develop a belief in their ability to time the ‘Red’ correctly. This shows overconfidence.
The same goes for market timing. It is difficult to determine a medium to long term trend of the market with past available data. It is even more difficult to time the interim tops and bottoms. Overconfident investors, who try to time the market, tend to trade more and end up with lower returns. A SIP is like bunch of Green cards as per above example. It falls right most of the time if not touched every now and then.
Nishit Siddharth Shah