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NISM Certifications · NISM-Series-X-B: Investment Adviser (Level 2) · Behavioural Finance in Practice

Mr. Raghunath Iyer, a 58-year-old investor, bought shares of a textile company at Rs 240. The price has since fallen to Rs 150, and the company's earnings outlook has deteriorated. He refuses to sell, saying he will exit only when the price returns to Rs 240. As his investment adviser, which bias best explains his refusal, and what is the most appropriate advice?

His reluctance to sell until the price recovers to Rs 240 is the disposition effect rooted in loss aversion and anchoring to cost. The adviser should ask him to assess the stock on future prospects as if buying today, ignoring the purchase price, rather than averaging down.

  1. ADisposition effect and loss aversion; advise him to evaluate the holding on its future prospects as if buying afresh, ignoring the purchase priceCorrect
  2. BOverconfidence bias; advise him to buy more shares to average the cost down
  3. CRecency bias; advise him to follow the latest market momentum and hold
  4. DRepresentativeness bias; advise him to switch entirely to the sector's best performing stock

Explanation

Holding a loser to avoid realising a loss and anchoring to the purchase price reflects the disposition effect, driven by loss aversion. The remedy is to judge the stock on forward-looking fundamentals, as if the decision were fresh, and ignore the sunk cost. Averaging down blindly would compound the error because the earnings outlook has weakened.

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