‘Anchoring bias’ in investing

Anchoring Bias is when we anchor ourselves to an old piece of information or to a state of the world that is not real. In this post, I’ll go over a few examples of anchoring bias that I have come across. The goal is to make you, the reader, and me, the writer, aware enough to spot such a bias when we come across it in future.

Anchoring to a specific rate of growth

Someone posted on Reddit that their portfolio XIRR had come down. Though this user had already met their savings target, many Reddit users were advising them to sell their mutual fund holdings only after the XIRR rises back to a reasonable number.

Let’s say we invest expecting a return of 11%. The market is good, and it gives us 17% return until a few months before we plan to cash out. We feel great. But the market sentiment changes suddenly and the rate of growth falters to 12%. If we wait for the growth rate to pick back up to 14 or 15%, then we are anchoring to a specific rate of return. 12% is still better than the expected 11%, so it’s better to follow the original plan and cash out now. Waiting for the value to go up is anchoring bias.

Let’s say I expected to amass ₹5,00,000 from my investments. The investment value becomes ₹7,80,000 one day, but soon falls down to ₹6,10,000. If I cash out now, I still have ₹1,10,000 surplus. If I stay invested, the value may go up to ₹6,80,000 or it may fall further to ₹4,50,000.

Anchoring to the acquisition price

I receive RSUs (restricted stock units) from my employer as a part of my compensation. A recent batch of RSUs vested at the price of $197.57. This was particularly high as the share had seen an uprise in the few days before the vesting date. When the newly vested shares were deposited into my account (T+2 days), the shares were trading at around $191.50.

I sell newly vested RSUs pretty much immediately, but this time I hesitated to sell the shares because the price had fallen.

I didn’t have any specific valuation in mind for these stocks. All I knew was that the price was now lower than it was at the time of vesting. Had the shares vested at $191, I would have gladly sold them for $191.50. My hesitation was only because I was anchoring to the vesting price.

Anchoring to a recent high

I was planning to sell a large number of my old RSUs this month (February 2025) because holding US assets is a bad idea. The price of the shares went up significantly in January, but I couldn’t sell then as the trading window was closed. I could sell in February, but the recent fall in the stock price made me hesitate.

The price of my RSUs has fallen by 5.74% in the trailing month

I lamented the ~6% fall in the past month, but I didn’t consider that the price was up by over 10% in the past 6 months even after the recent fall!

The price of my RSUs has risen by 10.62% in the trailing 6 months period

I was so anchored to the price movement in the past month that I had lost sight of how good the price still was.

Anchoring to tax rules of the past

Tax for gains from bond mutual funds went up significantly on 1-April-2023. Since then, I kept looking for “bond like” mutual funds that are taxed better. It took me close to 2 years to see that “bond like” mutual funds aren’t all that good. I was anchoring to a tax rate that was no longer available.

The impact of anchoring bias

If you are thinking, “What’s the big deal? Investors are humans too, and this is how typical humans behave,” you are right. But you need to be slightly better than typical humans to be a successful investor.

Before we start investing, we make an investment plan considering the risks and rewards. We are usually equanimous while we make the plan. What do we do when a bias gets the better of us? We change the plan on the fly. We dance to the tune of the market. That is not how investing success is achieved.

Modifying the plan mid-way is not a problem in itself. We often need to tweak our plans as we go along. But such changes should be holistic updates done without fear or excitement. Changing course solely based on market movement, arbitrarily changing asset allocation based on market sentiment, etc. don’t usually lead to anything good.

Conclusion

I don’t think it’s practically possible to eliminate all biases. But being cognizant of our biases can help us make better decisions. The ability to avoid biases can often be the difference between a good investor and a mediocre one.

Why you should avoid active mutual funds

The biggest reason I recommend against actively managed mutual funds is that most investors have a time horizon much longer than any AMC’s or the fund manager’s.

Assuming you start investing when you’re 40 and you live up to 80, your retirement portfolio has a lifespan of 40 years. Quite a few people will have portfolios with a longer time frame. Many would start investing at a younger age; many would want the retirement corpus to last for an additional decade or more. A lifespan of 50 or 60 years for a retirement corpus is not unusual.

It’s fairly easy to shortlist active funds that are great today. There’s a reasonable chance that these funds will stay good for the next 10 or 20 years. But change is inevitable. AMCs change hands; fund managers switch jobs; fund managers retire; investing landscape changes; regulations change. In a constantly changing world, it’s impossible to tell which of today’s top active funds will remain good 30, 40, 50 years from now.

A passively managed portfolio will never give you amazing, market beating returns, but the characteristics of such a portfolio won’t dramatically change later on. Anyone that likes a predictable portfolio over an unpredictable one should seriously consider passive management. (This is predictability relative to the market. A passive portfolio that replicates the market will always have the same amount of risk and return as the market itself. The risk and return of active portfolios can drift in either direction.)

While that’s my stance in general, I still use and recommend some actively managed funds. They are often hybrid or multi-asset funds that can act like “one fund portfolios” (meaning that’s the only fund you have in the entire portfolio).

• I use such funds to hold cash for a short duration (such as a few years). 
• I also recommend such funds to people who wouldn’t get any equity exposure otherwise. The chosen active fund may not be the best available, but if it’ll generate more return than a bank deposit. That’s often good enough.

The case for investing in NPS

I used to strongly recommend against NPS (National Pension System) because it doesn’t offer much flexibility to investors. It took me a while, but I eventually understood that NPS is a mass market product, and hence, it needs to account for the quirks of the “common people”. Recently I came across a few news stories that confirmed this.

News story 1: A vegetable vendor named Pradipkumar Vaishya has invested ₹4.55 crores in a Ponzi scheme called Torres. Reportedly, this capital belonged to him and others who invested through him. Torres shut down, taking with it many crores of rupees from investors like Pradipkumar Vaishya.

News story 2: A retiree has invested his entire life savings in an invoice discounting platform. He lost all his money when the firm shut down without notice. Many other investors have lost their capital too.

When looking at all this, it makes sense that NPS forbids people from squandering their retirement corpus. If falling for outright scams is one way to lose money, making emotional decisions is another.

You retire with a corpus that looks huge (but in reality it may be just enough to keep up with inflation). Someone in your family wants to borrow 10 or 15% of your corpus for some need. You think you have more than enough, so you lend it to them. They are never able to return the money. Inflation does its thing, and you are penniless in your final years. Or, maybe the borrower returns the capital without interest after 10 odd years, and you have lost a significant amount of interest that could have somewhat bridged the gap between inflation and your corpus.

A typical “common person” in our society is not good with money management. They are especially bad when it comes to living for a few decades off a corpus. Living off a corpus is a qualitatively different skill than managing one’s expenses with regular (or even irregular) cash inflow. Life doesn’t prepare us for it; we need to figure it out after we have retired. The vast majority of us will make mistakes. Some (many?) mistakes can have irreversible negative impact. It is an extremely hard problem.

NPS acknowledges this challenge and forces people to take a monthly pension. Even if the investor squanders all the money they have access to, the pension corpus stays intact and they’ll continue to receive some monthly cash flow.

I have strong opinions about how to invest my money. You—someone reading a blog post like this—also likely have strong opinions. NPS is most likely incompatible with our ideas and goals, so NPS is probably not a good fit for us. But we are outliers. For most people, NPS is a fine choice.

Holding RSUs because ‘they are there’

It is said that George Mallory, an English climber, was planning to climb Mount Everest for the third time. A reporter asked him why George Mallory wanted to climb again, and his reply was, “Because it’s there.” He wanted to climb the mountain because it was there.

Similarly, employees who receive RSU shares of their employer companies hold on to those shares. Ask a Microsoft employee if they want to hold Amazon.com shares. They’ll say No, but they’ll continue to hold their Microsoft shares. Ask a Facebook employee if they want to hold Walmart shares. They’ll say No, but they’ll continue to hold their Facebook shares.

These shares are held by those employees not as investments, but merely because “they are there” in their RSU accounts. If you are holding onto RSU shares of your present or past employer, ask yourself whether you are holding them because they are there or because you have a well thought out reason to hold them.

Correlation of assets in my portfolio

My investment portfolio has 4 assets: global equity, Indian equity, Indian bonds, and gold. I didn’t put this portfolio together myself; my financial advisor recommended this to me. I hesitantly took his recommendation because I couldn’t tell how good/bad this portfolio mix was.

I have been learning about portfolio construction for the past few months. As I learn about portfolio construction, I keep evaluating this portfolio—and I see that this is a great portfolio.

Recently, I have been thinking about asset correlation and how uncorrelated or negatively correlated assets make up resilient portfolios. Naturally, I checked the correlation of the assets in my portfolio. This is what I got, and as you can see, +0.3 is the worst correlation.

	US equity	Sensex	ABSL income
US equity	-
Sensex	0.3042	-
ABSL income	-0.2025	-0.4045	-
Gold	-0.4006	0.0400	0.0784

Notes about the data used to calculate the correlation. I couldn’t get data for the very specific assets I am investing in, so I used substitute data where necessary.

• I got US equity return data from the ‘Toolkit’ spreadsheet of portfoliocharts.com. This is the substitute for global equity data.
• For Indian equity, I am using Sensex data. I invest in a much broader index than Sensex, but this was the data I could get.
• I couldn’t get Indian bond return data, so I used the NAV history of the oldest debt fund, ABSL Income fund.
• The correlation is calculated based on their calendar year returns from 1996 through 2023.

Are “debt like” mutual funds better than pure debt funds?

Many thanks to Sayan Sircar for helping me understand many concepts that led me to eventually write this blog post.

Ever since the Indian government decided to tax debt mutual fund gains at the slab rate, I have been struggling to decide on a course of action. My initial intuition was that we should invest in the chosen assets and not worry about taxes. Then I changed my mind and I was attracted towards “debt like” funds that invest a significant portion of the capital in arbitrage.

But I had a constant nagging in the back of my mind because:

1. Arbitrage is constant work (for the fund management team) while debt funds are not as much work. I like the passive style of investing where “buy and hold” is the norm.
2. Arbitrage may not make as much money in bear markets (since futures may not sell at a good premium).

Arbitrage behaves differently than bonds, and I don’t exactly want arbitrage in my long-term portfolio. Until today, this was mostly intuition, but now I have some data to back it up. To make sense of that data, we must first understand correlation.

A primer on correlation

Correlation quantifies how 2 different investment assets behave relative to each other. A correlation of 0 means uncorrelated. When one asset’s movement doesn’t affect the other, we say they are uncorrelated. Cash is uncorrelated with all other asset classes.

Positive correlation means the assets move in the same direction; negative correlation means the assets move in opposite directions. We don’t want the correlation to be close to +1.0, which means the 2 asset classes behave mostly the same. That means there is no effective diversification.

A correlation close to -1.0 means the 2 asset classes cancel each other’s appreciation and we’d often end up with net zero return. This may sound unappealing, but rebalancing such a portfolio can be very rewarding. (In other words, such portfolios offer high rebalancing bonuses.)

Correlation between a few Indian mutual fund categories

I tried to get data for a few decades, but my attempts failed. ValueResearch provides calendar year returns for the last 9 years (2016 through 2024) at the fund category level. 9 years is not a long time period, but this is probably okay since this period includes both low and high interest rate markets. One interest rate cycle is better than zero! 😅

The correlation between mutual fund categories are shown in the following table.

Large cap : Arbitrage	-0.0312
Flexicap : Arbitrage	-0.0114
Large cap : Liquid	-0.2562
Flexicap : Liquid	-0.2593
Large cap : Short duration	-0.1700
Flexicap : Short duration	-0.1264
Large cap : 10-year gilts	-0.3884
Flexicap : 10-year gilts	-0.3740
Large cap : Dynamic bond	-0.3593
Flexicap : Dynamic bond	-0.3017

I had the intuition that arbitrage was similar to cash. The data confirms my intuition since arbitrage has a correlation (with equity) very close to 0. Shorter duration debt funds have correlation closer to -0.25 while longer duration debt funds have correlation closer to -0.4. (The Short Duration category falling between liquid and arbitrage is probably an anomaly caused by the small sample size of data we are working with.)

This is the metric I had to see to convince myself that pure bond funds are a better asset class to mix with equity. The lower correlation with equity means that an equity+bonds portfolio will have lower drawdowns than an equity+arbitrage portfolio.

My recent analysis quantified that the difference in post-tax growth rate is in the range of 0.5% to 1.5% annually. The difference in growth rate reduces as the holding period gets longer and longer. If we assume that a dynamic bond fund returns 0.5% more on average than an arbitrage+bond fund, then the net corpus won’t be very different between the 2 options.

Conclusion

1. Bonds, especially longer duration bonds, are a good asset to mix with equity. While arbitrage behaves like cash, bonds can provide meaningful downside protection (and provide meaningful rebalancing bonus).
2. For holding periods of 2 or more decades, the post-tax growth rate of bond funds is not too far from the post-tax growth rate of arbitrage+bond funds (source).
3. If we hold longer duration bond funds (such as dynamic bond funds), it is not unreasonable to expect that they’d yield 0.5% more return than arbitrage+bond funds. This further diminishes the difference in post-tax return.

The impact of “taxed at slab” — Take 3

I had quantified the difference between 30% tax and 12.5% tax—i.e., tax payable for bond fund gains vs tax payable for arbitrage+bond fund gains. The result of that previous analysis tilted in favour of paying less tax. The longer the holding period, the higher the impact of tax.

In a way, that analysis simply quantified what was already obvious. It is a well known fact that the gain (or value appreciation) increases exponentially as the holding period increases. The tax difference is flat 17.5% (30% – 12.5% = 17.5%). A flat percentage on a larger number will of course be larger than the same percentage on a smaller number. There wasn’t anything new to learn there other than quantifying what we can already know intuitively.

Now I want to measure the impact of tax differently, this time controlling for the exponential growth caused by longer holding periods. What if we calculated the CAGR of post-tax returns? That is, use a fixed pre-tax growth rate, compute the final corpus value, deduct estimated tax, and calculate the CAGR from original corpus to post-tax corpus.

When I do this, 2 things become noticeable:

1. The difference falls roughly in the 0.5% to 1.5% growth rate.
2. The longer the holding period, the lesser the impact on the growth rate. When I ran my previous analysis (i.e., take 2), this is what I expected to see, but I saw the opposite. It’s good to finally see data that validates my intuition.

Each cell in the following tables shows the post-tax growth rate. For example, look at the 6.5% row in the “3 years” table. This row says that if the pre-tax growth is 6.5%, the effective post-tax growth is 5.73% annualised when the tax rate is 12.5% and 4.63% if the tax rate is 30%. By paying higher tax, our investments (effectively) grow 1.1% more slowly each year.

For a holding period of 3 years, the difference in growth rate is 1.1%. If we extend the holding period to 10 years, the difference narrows to 0.96% (per annum). For 20 years, the gap reduces further to 0.78%.

But sensible readers would say that growth rates can go to hell. What really matters is the size of the final corpus, and hence, take 2 is a more useful analysis than this one. They’d be right, except the mutual funds that are taxed at 12.5% come with caveats.

An arbitrage+bond fund behaves differently than a pure bond fund. For some investors, the change in behaviour may not matter. But if the difference matters to you, you shouldn’t feel too bad about paying 30% tax. The impact of tax reduces as you hold the assets for longer and longer.

My conclusion is that long-term investors who plan on holding their investments for 2 or more decades can use this data to rationalise holding pure bond funds. This analysis doesn’t magically reduce the tax we pay, but it changes the narrative to convince oneself to choose a simpler investment asset (pure bond) over a more complex one (arbitrage+bonds).

Num of years ➡	3 years
Growth rate⬇ / Tax rate ➡	12.5%	30.0%	Growth rate Δ
4.5%	3.96%	3.19%	0.77%
5.0%	4.40%	3.55%	0.85%
5.5%	4.84%	3.91%	0.93%
6.0%	5.29%	4.27%	1.01%
6.5%	5.73%	4.63%	1.10%
7.0%	6.17%	5.00%	1.18%
7.5%	6.62%	5.36%	1.26%
8.0%	7.06%	5.73%	1.34%
8.5%	7.51%	6.09%	1.42%
9.0%	7.96%	6.46%	1.50%

Num of years ➡	5 years
Growth rate⬇ / Tax rate ➡	12.5%	30.0%	Growth rate Δ
4.5%	3.98%	3.23%	0.75%
5.0%	4.43%	3.60%	0.83%
5.5%	4.87%	3.97%	0.90%
6.0%	5.32%	4.34%	0.98%
6.5%	5.77%	4.72%	1.06%
7.0%	6.22%	5.09%	1.13%
7.5%	6.67%	5.47%	1.20%
8.0%	7.12%	5.85%	1.28%
8.5%	7.58%	6.23%	1.35%
9.0%	8.03%	6.61%	1.42%

Num of years ➡	10 years
Growth rate⬇ / Tax rate ➡	12.5%	30.0%	Growth rate Δ
4.5%	4.03%	3.33%	0.70%
5.0%	4.48%	3.72%	0.77%
5.5%	4.94%	4.11%	0.83%
6.0%	5.40%	4.50%	0.90%
6.5%	5.86%	4.90%	0.96%
7.0%	6.32%	5.31%	1.02%
7.5%	6.79%	5.71%	1.08%
8.0%	7.25%	6.12%	1.13%
8.5%	7.72%	6.53%	1.19%
9.0%	8.19%	6.95%	1.24%

Num of years ➡	15 years
Growth rate⬇ / Tax rate ➡	12.5%	30.0%	Growth rate Δ
4.5%	4.07%	3.41%	0.65%
5.0%	4.53%	3.82%	0.71%
5.5%	5.00%	4.23%	0.76%
6.0%	5.47%	4.65%	0.82%
6.5%	5.94%	5.07%	0.87%
7.0%	6.41%	5.50%	0.91%
7.5%	6.88%	5.92%	0.96%
8.0%	7.36%	6.36%	1.00%
8.5%	7.83%	6.79%	1.04%
9.0%	8.31%	7.23%	1.08%

Num of years ➡	20 years
Growth rate⬇ / Tax rate ➡	12.5%	30.0%	Growth rate Δ
4.5%	4.10%	3.50%	0.61%
5.0%	4.58%	3.92%	0.66%
5.5%	5.05%	4.35%	0.70%
6.0%	5.52%	4.78%	0.74%
6.5%	6.00%	5.22%	0.78%
7.0%	6.48%	5.66%	0.82%
7.5%	6.96%	6.11%	0.85%
8.0%	7.44%	6.56%	0.88%
8.5%	7.93%	7.01%	0.91%
9.0%	8.41%	7.47%	0.94%

Num of years ➡	25 years
Growth rate⬇ / Tax rate ➡	12.5%	30.0%	Growth rate Δ
4.5%	4.14%	3.57%	0.57%
5.0%	4.61%	4.01%	0.61%
5.5%	5.09%	4.45%	0.64%
6.0%	5.57%	4.90%	0.68%
6.5%	6.06%	5.35%	0.71%
7.0%	6.54%	5.81%	0.74%
7.5%	7.03%	6.27%	0.76%
8.0%	7.51%	6.73%	0.78%
8.5%	8.00%	7.20%	0.81%
9.0%	8.49%	7.66%	0.83%

Num of years ➡	30 years
Growth rate⬇ / Tax rate ➡	12.5%	30.0%	Growth rate Δ
4.5%	4.17%	3.64%	0.53%
5.0%	4.65%	4.09%	0.56%
5.5%	5.13%	4.54%	0.59%
6.0%	5.62%	5.00%	0.62%
6.5%	6.10%	5.46%	0.64%
7.0%	6.59%	5.93%	0.66%
7.5%	7.08%	6.40%	0.68%
8.0%	7.57%	6.87%	0.70%
8.5%	8.06%	7.35%	0.71%
9.0%	8.55%	7.83%	0.73%