Biases in Mutual Fund investing often lead even the most well-informed investors to make poor financial decisions. These biases represent subtle psychological traps that cloud judgment and hinder rational decision-making. While mutual funds are designed to offer diversification and professional management, they are not immune to human error. Investors frequently fall victim to emotional and cognitive biases—such as overconfidence, herd mentality, or loss aversion—that quietly influence their choices. As a result, mutual funds often become arenas where these biases manifest, undermining the benefits they are supposed to provide.
From exiting in fear during market dips to riding highs launched by overconfidence during rallies, such behavior of investors acts upon mutual fund results-not due to the ability of the fund, per se, but due to the way it is used. Such mutual fund biases, including herd mentality and loss aversion as well as confirmation bias, may cause investors to buy high and sell low or hold on to poorly performing funds through misplaced loyalty or fear of regret.
The article thus considers-and takes measures to counteract-the most common behavioral biases affecting mutual fund investors. As an NRI, offshore investments may interest you, as a beginner, you could be starting SIPs and, as a retiree, you would seek to protect your corpus. Whatever your profile, getting a grasp on these biases will be cardinal for mutual fund-based long-term wealth creation.
Let’s Explore Top 10 Biasis
1. Anchoring Bias – When First Impressions Mislead
Biases in Mutual Fund investing can significantly distort rational decision-making, and one common example is anchoring bias. This occurs when the investor clings too tightly to the first piece of information they encounter—such as a mutual fund’s past NAV or its ranking from a year ago. For instance, if an investor initially hears that a particular fund delivered a 25% return last year, they may anchor their expectations to that figure and assume similar future performance, ignoring changes in market dynamics or sectoral shifts. Among the various biases in mutual fund investing, anchoring particularly affects exit strategies; many investors hesitate to sell a fund below its purchase NAV, regardless of the current or projected performance. To avoid this pitfall, it’s crucial to re-evaluate holdings based on updated fundamentals and market context rather than relying on outdated benchmarks. Tools like rolling returns, risk-adjusted performance metrics, and the fund manager’s tenure offer more grounded insights for decision-making.
2. Loss Aversion – Why Losing ₹1 Hurts More Than Gaining ₹5
Biases in Mutual Fund investing can significantly distort rational decision-making, and one common example is anchoring bias. This occurs when the investor clings too tightly to the first piece of information they encounter—such as a mutual fund’s past NAV or its ranking from a year ago. For instance, if an investor initially hears that a particular fund delivered a 25% return last year, they may anchor their expectations to that figure and assume similar future performance, ignoring changes in market dynamics or sectoral shifts. Among the various biases in mutual fund investing, anchoring particularly affects exit strategies; many investors hesitate to sell a fund below its purchase NAV, regardless of the current or projected performance. To avoid this pitfall, it’s crucial to re-evaluate holdings based on updated fundamentals and market context rather than relying on outdated benchmarks. Tools like rolling returns, risk-adjusted performance metrics, and the fund manager’s tenure offer more grounded insights for decision-making.
3. Herd Mentality – Following the Crowd into Trouble
Humans are social creatures, and this instinct often spills into investing. One of the most common biases in mutual fund investments is herd mentality—when investors mimic the actions of a larger group by buying into trending funds without proper due diligence. This particular bias can be disastrous during market booms or thematic surges (like tech, ESG, or infrastructure funds). For instance, during a bull market, aggressive funds receive disproportionate inflows, even from risk-averse investors. Such biases in mutual fund decisions often lead to disappointment when markets correct. Instead of following the crowd, investors should ask: Does this fund suit my financial goal and risk profile? Personalized asset allocation should always take precedence over public hype. Tools like Morningstar or Value Research can help compare category averages and fundamentals before making investment decisions.
4. Recency Bias – Believing the Recent Past Predicts the Future
Increased biases in mutual fund make an investor less rational, particularly the occurrence of one such bias, recency. This specific bias concerns the tendency to place excessive weight on recent events in investment decisions. If the discussion concerns mutual funds, then very often the price for this perception is the recent 3-6 month returns of a fund. The medium- or long-term periods may witness the fund being average at best or so volatile that it may not suit short-term speculators and such funds can attract huge rush from speculators just because it has gone up in the last month or two or three. This in turn results in an unhealthy focus on swapping or switching the funds to meet the level of short-term returns. To keep such biases from arising from a form worthy of consideration during mutual fund selection, an investor must look at longer periods, say 3, 5, and 10-year rolling returns adjusted for consistency while considering their long-term goals. Having tools such as SIP performance calculators and quartile rankings can definitely be more helpful than relying on short-term return charts.
5. Confirmation Bias – Seeing Only What You Want to See
In mutual fund investing, such biases can considerably hamper objective decision-making. In the case of confirmation bias, investors tend to look for only that information which supports their preforming set of beliefs and neglect anything contradicting their views. For instance, the adage that “small-cap funds are the best wealth builders” might prompt a prospective investor to just float around in the ocean of articles, fund reviews, or YouTube videos that supports his/her belief, thus limiting the scope for analysis and leading him/her to poor decision-making. To remove such biases in mutual fund, during the selection of mutual funds, investors must intentionally explore every possible different point of view and sources. Having a standardized checklist to evaluate the funds or talking to an advisor registered with SEBI can both help in questioning far-reaching assumptions toward balanced investment decisions.
6. Overconfidence Bias – Believing You’re Smarter Than the Market
Being overconfident is a two-edged sword. Optimism is its fuel, but it can also impair judgment-one area where it can do immense harm is investing. A large portion of the DIY investors think they have an edge, or to put it another way, they believe that they can spot hidden gems from mutual funds. This thought goes into lottery-like churning of portfolios with more risk-taking and transaction costs-munificent examples of biases in mutual fund choices borne on the notion of somehow having control. These investors, however, disbelieve in experts-they’d rather follow their intuition than consider knowledge. Fact is, even the best fund managers, after 10 or 20 years in the field, find it challenging to keep beating the presence of this antidote: a little humility, disciplined investing through SIP, and a diversified portfolio. Therefore, projection of acknowledgments is not a weakness-it is the strength that keeps long-term wealth afloat.
7. Disposition Effect – Holding Losers, Selling Winners
One of the finest loopholes and yet one of the most influential in mutual fund investing is probably the disposition effect—one of the behavioral economic concepts closely associated with loss aversion. It basically entails selling all good investments too early, while holding on to the bad ones, hoping that they might turn around. If ever you felt the need to cash in on profits from your top-performing fund but found yourself hesitating at the thought of letting go of one that’s been trailing behind, then you’re also not alone. That more than anything is an emotional drain on your portfolio’s potential over time. Good news-the bias can be countered by sticking to a reinvestment strategy in which the only noise considered is that of market prices relative to your own objectives, risk tolerance, and time frame. Truly, having an awareness of these biases in mutual fund and managing them when it comes to mutual funds selections can very well become the main difference in the accumulation of wealth over a lifetime.
8. Familiarity Bias – Investing Only in What You Know
A prominent biases in mutual fund investing is familiarity—that is, sticking to what feels safe and familiar. For many investors, it means picking the same mutual fund schemes again and again from large names like SBI or HDFC, even when those might not fit into their objective or risk profile anymore. Some just might steer clear of global funds, because of simply not being familiar with them. But the comfort approach can bring about undesirable diversification and lost opportunities. Recognizing these biases and getting past brand names can avail of further investment opportunities. International funds, thematic strategies, or dynamic asset allocation models will allow many more pathways to smarter and fitting investment decisions.
9. Choice Paralysis – Too Many Funds, Too Little Clarity
More than 2,000 mutual fund schemes are under operation in India, a number that somehow sets up an elaborate mental marathon for anyone to select one rather than just a business decision. The multiple alternatives confuse even the best of investors and bring about what is called a “choice paralysis.” This is when, under stealth, certain mutual fund biases creep-in: For example, sticking to familiar names or going with recent performance rather than long-term fundamentals. An investor might be standing outside the gates of ELSS units for tax planning late in the season: should they take Axis, Mirae, or Quant? They are terrified of missing out. Perhaps the price of this indecision is the loss of tax returns and perks. Awareness of these smaller biases helps cut through selection, allowing one to focus on alignment of goals, risk tolerance, and fund track record so that they can confidently start working on investment. Getting lists of funds vetted by the experts or a financial adviser can logically help smooth out the bumps of financial decision-making, limiting inertia created by emotional and cognitive biases in mutual fund.
10. Mental Accounting – Treating Money in Silos
Mental accounting is one of the common biases in mutual fund investing that many people experience without even realizing it. It happens when investors mentally separate their money into different “buckets” — for example, treating SIP investments differently from lump-sum ones or thinking of dividends as “bonus cash” to spend freely. This kind of thinking can lead to poor decisions and inefficiencies in managing your portfolio. The key to overcoming these biases in mutual fund investing is to focus on a goal-based approach, where every investment ties back to a meaningful life goal like retirement, education, or buying a home. Using portfolio tracking tools and consolidated statements can really help bring all your investments into one clear picture, making it easier to stay on track.
📌 How to Overcome Behavioral Biases in Mutual Fund Investing
Recognizing these biases is the first step, but managing them requires intentional strategies. Here are some practical tools and practices:
1. Create an Investment Policy Statement (IPS) outlining your goals, time horizons, and risk appetite.
Explanation:
An Investment Policy Statement (IPS) acts as your personal investing roadmap. It defines what you’re investing for (e.g., child’s education, retirement), your investment horizon (e.g., 5, 10, 20 years), and your ability to take risks (low, medium, high).
Example:
Let’s say Priya, a 35-year-old salaried professional in Bengaluru, wants to accumulate ₹1 crore for her daughter’s higher education in 15 years. Her IPS states:
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🔑 Goal: Child’s education
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🔑 Time horizon: 15 years
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🔑 Risk tolerance: Moderate
If the market falls sharply and her equity mutual fund drops 10%, instead of panic-selling, she refers to her IPS. It reminds her that this is a long-term goal and short-term volatility is expected. This helps her stay disciplined and avoid decisions driven by loss aversion or recency bias.
2. 🔁 Automate investments using SIPs and STPs to reduce emotion-based decisions.
Explanation:
Systematic Investment Plans (SIPs) and Systematic Transfer Plans (STPs) automate your investments. This reduces the temptation to time the market or make emotional decisions during volatility.
Example:
Rahul, a young IT engineer, sets up a monthly SIP of ₹10,000 into a diversified equity mutual fund. He also uses STP to gradually shift ₹5 lakhs from a liquid fund to an equity fund over 12 months. Even when the Nifty drops by 5% in a week, Rahul doesn’t stop his SIPs. Automation shields him from biases like herd mentality or overconfidence in market timing.
3. 🗓️ Perform quarterly portfolio reviews rather than reacting to daily market movements.
Explanation:
Checking your investments too often leads to anxiety and reactive behavior. Reviewing quarterly helps you focus on long-term trends instead of short-term noise.
Example:
Neha, a retired banker, used to check her mutual funds daily. She’d often sell funds after a week of underperformance, falling into the recency bias trap. Her advisor suggested reviewing only once every quarter. After implementing this, she noticed reduced stress and better performance. She now tweaks her portfolio only when needed, aligned with her goals.
4. 🤝 Work with a SEBI-registered investment advisor (RIA) for unbiased advice.
Explanation:
SEBI-registered Investment Advisors are legally bound to offer fiduciary advice. They help you filter out noise and avoid biases in mutual fund, like confirmation bias or anchoring.
Example:
Amit, a 45-year-old businessman, reads online that a mid-cap fund gave 80% returns last year. He’s tempted to invest heavily. His RIA reviews Amit’s portfolio and points out that his goal is capital preservation and this fund doesn’t align with that. Thanks to professional advice, Amit avoids anchoring his expectations to last year’s performance and sticks to a balanced portfolio.
5. 🤖 Use robo-advisors or fund selection tools to make data-driven choices.
Explanation:
Robo-advisors use algorithms to recommend funds based on your goals and risk profile (like Zerodha. This reduces emotional decision-making and eliminates biases in mutual fund such as familiarity bias.
Example:
Sneha, who’s new to investing, tends to choose funds from banks she has accounts with — a classic familiarity bias. A robo-advisor app asks her a few questions about her goals and risk appetite, then recommends a portfolio of diversified funds — none from her bank. The tool uses data, not emotions, to guide her, ensuring better diversification and performance.
6. 📓 Maintain a journal to record reasons for buying or selling a fund—this helps track emotional triggers.
Explanation:
By writing down your motivations behind every investment action, you create self-awareness. You can later evaluate if your decisions were logical or emotionally driven. I personally also track the same way, as few year back i was busy in my work and i myself forgot the investments of my wife, hence thereon i started maintaining a text file in my google drive.
Example:
When Karan sold his international fund in 2022 after a brief underperformance, he wrote in his journal: “Sold due to rising dollar and fear of US market crash.” One year later, that fund had recovered 30%. Reading his old note, Karan realized his decision was driven by fear, not fundamentals. Going forward, he began reviewing journals before making changes — helping him tame loss aversion and recency bias.
6. 📓 Maintain a journal to record reasons for buying or selling a fund—this helps track emotional triggers.
Explanation:
By writing down your motivations behind every investment action, you create self-awareness. You can later evaluate if your decisions were logical or emotionally driven. I personally also track the same way, as few year back i was busy in my work and i myself forgot the investments of my wife, hence thereon i started maintaining a text file in my google drive.
Example:
When Karan sold his international fund in 2022 after a brief underperformance, he wrote in his journal: “Sold due to rising dollar and fear of US market crash.” One year later, that fund had recovered 30%. Reading his old note, Karan realized his decision was driven by fear, not fundamentals. Going forward, he began reviewing journals before making changes — helping him tame loss aversion and recency bias.
Summary of Investor Biases in Mutual Fund Investing
***IOI = Impact on Investors
| Bias | Impact on Investors | Solution |
|---|---|---|
| Anchoring | Misjudging value based on past data | Focus on fundamentals |
| Loss Aversion | Holding losers too long | Accept small losses early |
| Herd Mentality | Investing based on trends | Stick to your plan |
| Recency Bias | Overvaluing recent performance | Use long-term returns |
| Confirmation Bias | Ignoring red flags | Read contrarian views |
| Overconfidence | Overtrading, higher costs | Trust SIPs and diversification |
| Disposition Effect | Selling winners, holding losers | Rebalance regularly |
| Familiarity Bias | Limited diversification in known options | Explore varied categories |
| Choice Paralysis | Delays decision-making due to too many choices | Use filters and advisor help |
| Mental Accounting | Separating money irrationally across accounts | Combine portfolios by goal |
Conclusion
Biases in mutual fund investing can surely go a long way in defeating one’s financial objectives. While mutual funds provide professional management and diversification, they do not shield such investors from their own mental traps. The knowledge of these biases in mutual fund decisions prevents making expensive mistakes. Some of the most common biases that tend to influence investor behavior and produce ill-timed or irrational choices are herd mentality, overconfidence, and loss aversion. Some strategies to curb bias while investing in mutual funds are disciplined investing through SIPs, periodic portfolio review, and goal-based planning. The identification and dealing of biases in mutual fund investing will allow one to focus, sharpen decision-making ability, and further develop and put together a better, more rational portfolio with time.