Top Ten Mistakes To Avoid When InvestingMay 26, 2021
“The average investor wants only one thing: the right stock pick, one that will go up forever, starting immediately” – Nicholas Vardy. The word “investment” invokes the thought of prosperity, and that too, a lot of it and quickly. It is, therefore, no surprise that most of the beginner investors tend to overlook or misjudge some fundamental rules of investing, thereby resulting in, sometimes, catastrophic outcomes. While there are over 20 common mistakes investors make when investing we have listed here 10 that we believe take precedence.
Mistake No. 1: Absence/Ignorance of clear investment objectives
For people looking to secure their retirement, it is easier done with the selection of a retirement plan than for those who wish to invest for reasons other than retirement. It is the latter set of people who need to chalk out the purpose, tenure, target sum and risk tolerance as part of their investment objectives, without which any and all investments could turn out to be out of sync, and fall short of their desired outcome.
Without a clear investment objective, all financial endeavors become subjective.
Mistake No. 2: Complete disregard for asset allocation
Not many might know that more than the selection of investments it is the allocation of asset class that attributes to 60-90% of the portfolio performance. Imagine a portfolio laden with just “safe haven” gold bullion during the 2011-2015 period. It would have been a slow hemorrhage of 25% drop in the portfolio value over a 5-year period lest any growth. Or a young investor planning for his family and retirement has the best of bond portfolio with zero allocation to equities. Instead of picking the next hot stock or top performing fund spend your limited resources and time to determine the right asset classes and strategies. As per Pareto’s law, 80% of your results come from 20% of your efforts. That 80% should be asset allocation, not stock picking.
Focusing on stock picking instead of correct asset allocation is akin to missing the forest for the tree.
Mistake No. 3: Having unrealistic expectations
As mentioned at the onset, investors, mostly beginners tend to expect high expectations from their investments, especially equities. Long term average annual returns from equity markets in developed countries fall in the high single-digit zone. Any sudden or irregular spurts of high octane returns are an exception, not the rule. It is prudent to manage one’s own expectations and stick to the rule. Keep your expectations within reality instead of any rosy picture of outsized returns in short periods of time.
“A reasonable probability is the only certainty” – E. W. Howe
Mistake No. 4: Relying on past performance
Not only that past performance is no indication or guarantee of future results has been a universal truth as well as a disclaimer in all financial product offerings, but is also generally forgotten. Majority of investors tend to consider past performance as the yardstick to select an investment product. The major risk with that thought process lies in the fact that the particular product or category may have already run its course of outperforming the benchmark or the peer group, and may be in the process of giving way to some other investment themes.
Historical returns are just that, historical.
Mistake No. 5: Inadequate diversification
Diversification in investments simply means having your money spread across different asset classes such as cash, bonds, equities, real estate or precious metals. During adverse market conditions not all asset classes head south. Bonds and gold tend to do well during stock market drop. I remember a young rookie Wall Street broker approaching me in my yester years to review his recommended model equity portfolio. He had almost two dozen names, but all in the technology sector. The portfolio was nowhere close to a true diversification. Beginners must avoid the concentration risk by spreading their investment across industry, sector and style of investment. On the other extreme, spreading your portfolio in too many names also beats the purpose of diversification. Some experts call this overdrive “Diworsefication”.
Diversify your portfolio by adding independent and contrarian sources of return.
Mistake No. 6: Chasing tips and media noise
It is not uncommon to find every third person trying to give you a tip about how to make money or how to pick stocks. Most of the tips come your way are from people who are expert by their imagination, and not from profession. Whether you are given an unfounded tip in a bar, on the greens, or by a friend, they often do not pan out. If they do, it can only mean two things: (i) The tipper is perceivably very smart (then he must be rich himself or is he really?) and (ii) he must be an insider, which is illegal anyway. Now, combine that with media screaming daily about the market with dramatic presentations, obscuring your view. The media knows that hype and fear attract viewers and readers. It is best to cut through the temptation of tips and media noise, and instead calmly target well-researched investment ideas suitable to your requirements.
Never invest on rumours, stories, conjecture or hot tips.
Mistake No. 7: Timing the market
Buy low and sell high has been the age old mantra of investing. While it works well for the short term horizon, which is more of trading than investing. But, for the long term, trying to time the market never works. In the process of identifying short term tops and bottoms, one tends to miss out on the best trading days (most up days) because the peaks and troughs are mostly seen in the rear view mirror. It is, therefore, best to stay invested in quality products and avoid pushing the panic button during the interim volatility.
It is the time, not the timing that makes your wealth grow.
Mistake No. 8: Holding losing positions at the cost of winnings ones
Investing has no room for emotions. One of the defining characteristics of a successful investor is his/her ability to quickly take a loss on a trade going against expectation. A lot of investors tend to cling on to a losing position, and average down on further dips in the price. Many a times, an investor's ego or love for the stock registering a new unrealized loss prompts him to give sacrifice of the winning stock, and plough its proceeds into their favorite name. This is a common mistake of throwing good money after bad investment. The best way to grow your equity is not to lose any or plenty to begin with. The rightly named “Stop-loss” orders can help you contain any downside exposure beyond a certain limit as they are placed below the prevalent market price. These orders can also be used to protect the unrealized gains in case the position heads south. What is better – having several small losses and few big profits or the other way around?
A simple, yet forgotten, golden rule is to cut your losses short and let your profits run.
Mistake No. 9: Following herd mentality
Another common mistake new traders make is follow the herd. This results in crowded buy orders in an already hyped stock thereby unnaturally pushing the price higher or going short too late on a stock already tumbled too deep. The dot com bubble at the turn of the century, then grossly misperceived to be the “next big thing”, is a great example of irrational exuberance in the technology sector. Then any name registered with “.com” at the end used to create frenzied buying interest with no regard for the company's fundamentals (which were pretty much non-existent). The craze created a super bubble in the sector that had to burst someday. The tech crash crushed millions of investors under huge losses and debt. While it is the right thing to do to identify the favourable trend in an asset class or industry, it is sheer carelessness to blindly follow the crowd.
A contrarian approach is an important trait of a prudent investor.
Mistake No. 10: Lack of discipline
Like in other spheres of life to be successful, wealth creation also requires a disciplined approach for success. Discipline encompasses several important aspects of investing. These include selection of suitable financial product, investment style – fundamental or technical, avoidance of the leverage trap, limitation of maximum exposure to single stock or industry, portfolio synchronization with investment objective, regular portfolio review, and exit strategy among others. While it is always advisable to remain flexible in the ever-changing world of investments, one still needs to stay the course of one’s strategic financial objectives with a certain degree of discipline. Steering clear of the common mistakes mentioned in this article also falls under the ambit of discipline.
Discipline is the backbone of all sustainable successes.
By avoiding these mistakes you can dodge unwarranted financial stress and build a simple yet well-thought out investment portfolio for wealth creation.
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