Don’t buy a cake for the cherry on it

This is an analogy I learnt from my manager at work. It aptly fits investing to save tax.

We should choose investment assets based on the merit of the assets. If the investment also comes with tax benefits, then that’s an added plus. If the investment asset is a cake, tax benefits are the cherry on that cake.

Only buy the cake that you want to eat. Enjoy the cherry if the cake comes with a cherry. But don’t buy a less than delicious cake only to get a cherry.

Picture by phiraphon srithakae from Pexels

To invest is to go out on a limb

Investing is an act carried out mostly in faith. We can look at hundreds of different data points or read dozens of books and research papers. But none of that—literally none of that—can guarantee anything about the future.

Any asset we pick, any strategy we pick—there will be a dozen arguments supporting them and a dozen opposing them. Which arguments should we accept and which ones should we ignore?

We have to go out on a limb and make our bets. We may get the returns we wanted, or we may not. The risks we took great care to avoid may play out, or they may not. If the risks play out, we get to feel smart; if they don’t, we get to look like fools for not getting on the bandwagon.

Investing is a humbling exercise. It shows us how powerless we are. It’s also an empowering exercise. It forces us to march on even when the path is dark and our legs trembling.

Picture by Caio Triana from Negative Space

Being aware of emotions

The good news is that awareness is a significant half of the solution. Knowing how and when we allow emotions to hijack us is the first step towards a solution.

The bad news is that awareness is only half the solution. When I become aware that I am acting in anger, I am usually left puzzled about what to do next. I need to pause and reconsider the situation to decide on a response. Sometimes there is just nothing for me to do, i.e., the situation is simply beyond my control.

As someone who used to get hijacked by emotions on a regular basis, this awareness is making me uncomfortable. I am still figuring out how to deal with it. I suppose I should be proud, but I don’t feel that way yet… I am still confused. 😅

Emotions hijack us

This happens often. I am in the process of doing something, but a seemingly stupid thing prevents me from doing it. I become angry. That “stupid thing” may be a broken tool or someone’s inexplicable policy or someone not living up to my expectations. Essentially, something that is not in my control blocks me.

Often, this enrages me. I go on the offensive and my focus turns into hurting or humiliating this entity or person whom I am upset with. Naturally, I forget about my original goal. Hurting/humiliating becomes the priority now.

Photo by Andrea Piacquadio

But angry responses seldom help. People are more likely to cooperate when I am nice than when I am yelling at them. I cannot persuade an inanimate tool by being nice, but being angry is no better. If I shifted my focus to what I want to accomplish rather than cursing the broken tool, I’ll likely come up with an alternate solution.

Emotions hijack us. We should avoid getting hijacked. When we unconsciously allow ourselves to be hijacked, we should be flexible/humble/honest enough to drop the emotion and course correct.

‘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.