Selection and investment aims of the portfolio

Nowadays individuals are becoming more aware of their personal financial future because of the mixture of higher self responsibility for retirement along with an aging population. Thus, the requirement to invest for supporting the retirement is extremely important. Considering the significant impact of current investment choices on future lifestyles (Browning and Crossley, 2001), it is crucial to know the theory of efficient management of asset to optimize our investment return for achieving our investment goal. It is observed that though investment in stocks are viewed as risky but historically, the return from investment in shares have outperformed all other forms of investment.

Selection of investment

 
From the above portfolio it can be stated that my strategy of investment is to diversify it into different section or industries diversifying investments does not guarantee profit but it hedge the risk associated “by not putting all egg in one bucket” along with not compromising the return from investment

• Investment Aim

The main motivation of this project is to choose and compute my investment choices in various stocks. It also takes account of the investment performance of my portfolio along with the focus on decreasing the risk associated with it by diversifying the assets. Hence it ensures that my present investment gives strong support to my future by funding my retired life expenses.

Possible Biases

Behavioral bias has sufficient influence over investors for making wrong decisions. Where as there are several other biases that describes how people form beliefs under uncertainty.

• Overconfidence

Overconfidence implies overestimation of individual’s ability and knowledge (Alpert and Raiffa, 1982). It is observed that investors frequently tend to overestimate personal confidence in the positive outcome from the past, at the same time forgetting their failures. Partially, overconfidence arises due to self attribution bias (Keith Red head, 2010).

• Hindsight bias

Hindsight bias refers to the tendency of an individual to perceive their better performance rather than the exact outcome even after actual realization. It is anticipated that one should always learn from the past and must adjust to the present based on that learning. But incase of investors with hindsight bias, they do not learn from the past and takes those events as inevitable. According to Vein, Biais and Weber (2008), investors do not remember their past experiences which lead them to underestimation of volatility and thus poor performance.

• Familiarity Bias

Familiarity bias arises due to the fact that individuals prefer to invest on stocks that they are mostly familiar with. This may happen because the investors  may prefer from their  geographical region over foreign entities and thus believe in investing  it to be safer than any diversified portfolio. This exposes their investment to unsystematic risk.

Portfolio asset allocation using Behavioral Approach

Regret Avoidance

According to the main theory by Kahneman & Miller, 1986, individuals feel greater regret and consider themselves responsible if their act deviates from the conventional structure. Hence if an individual miss the opportunity to buy a stock for a lower price then to avoid regret, it is less likely that they will invest on that stock. This reluctance is mainly due to the avoidance of regret over missing the good price.

• How Bias influences my investment choice

A brief research on several psychological biases has given me better analysis of low                feelings and emotions affect the investors in the investment making decisions. Therefore I have used a strategy which will account all available information like inflation interest rate and economic growth to make a rational investment decision .I have also considered the aim of investment amount of capital available tolerance of risk and future investment of capital to construct an efficient portfolio. 

Return from the portfolio = 0.000453844

Standard deviation of the portfolio = 0.006973271

In order to hedge the risk of losing money due to negative performance of stock investment portfolio has to be diversified across several assets. In real life it is not possible to determine any pattern for investment in various assets as the performance of stock varies from year to year. Hence to hedge this risk investors diversify their investments into different entities like shares bonds real estates and bank deposits.

Investors diversify their stocks across firms operating in various industries and their sizes in terms of the company net worth. This facilitates the losses incurred by any sector to be compensated by the profits of the other sector. It is crucial to take into account both growth and style of investment in order to reduce volatility. It is also very important to hold a variety of stocks that are less correlated with each other in the portfolio to hedge the risk.

It is suggested by Armstrong (2008) that optimizing market portfolio requires including both domestic and foreign companies in it. It is observed that for an internationally diversified portfolio lower portfolio beta exists as the return from domestic stocks are not highly correlated with returns on foreign stocks.

Securities having negative correlation imply zero risk. The Markowitz equation theory incorporates stocks with low correlation of returns. In my portfolio, there are 9 assets with highest correlation coefficient equal to and lowest correlation coefficient equal to. The portfolio of lower correlated assets has lower volatility.

The table below gives the 5 best assets: –

Markowitz Approach is used to select the 5 best assets, which accounts both the factors of low correlation of return without compromising returns.