In my last few years of experience while interacting with people in my office, my friend circle and acquaintances; I realized that most of them belongs to two of the categories one who finds the stock market as amazing and thrill giving medium on your investments (Active speculators) and the ones who believe that investing is a 3-step process i.e. getting hold of an investment agent, filling up an application form and signing a cheques (Passive deposiors). Both of them got it wrong, as Benjamin Graham (http://www.investopedia.com/university/greatest/benjamingraham.asp#axzz1udzLtdPE) once said “The investor’s chief problem – and even his worst enemy – is likely to be himself.” One (Active speculator) need to understand that the investment is not a thrill seeking game, If you like to take risk at least limit your exposure to it and segregate your investments and gambles. On the other hand Passive depositors need to understand that just planting the seeds does not bring fruits to you, one has to pu some effort to nourish and care for the tree he want to grow.
To be an investor, one need to understand that investing is a process driven approach and processes requires your time & effort both. While investing, person should ideally ascertain their investment objectives, and thereafter invest in appropriate investment avenues which help them attain the set objectives. Although this may sound a little difficult, it can be achieved by avoiding some very common investment mistakes. While there are galore of mistakes which investors do (while investing) – and the list is endless; I tried to highlight below the five most common mistakes and guided what investors’ should actually do.
Journey without a destination
As Suboo says “Failing to plan is planning to fail’. The most critical step while investing as mentioned above, is to outline your investment objectives. Setting an investment objective simply means ascertaining why you would like to invest, along with the financial goal which you have in mind. And mind you, segregating your financial goals not only in terms of how much money you want but also the time frame. For instance planning for vacation is short-term, planning to buy property is medium to long-term, planning for retirement is long-term or child’s education/ marriage.
But through experience I can say, very often investors stumble at the starting point while defining investment objectives; this in turn gets their financial plan in a tizzy.
When diversification means buying 100 random stocks in place of five good ones
Diversification is one of the basic tenets of investing. During my meetings and discussions, I regularly find people who have invested their money in various stock or tens of MFs available in market and on other hand many people invest a large portion of their hard-earned money in a single asset like real estate for instance, or equity. This happens basically because of the false understanding of diversification, while such investors may do well during a run-up of a respective asset class, the risk also gets elevated during the downturn of the respective asset class.
Thus this highlights the point of how vital it is to put your eggs in different asset classes (such as equity, debt, gold, and real estate). Moreover, diversification is also important within an asset class. So, say while you would like to invest in a respective companies stock/Fund (in the equity asset class) for all the robust fundamentals it holds, you should be diversifying your portfolio across stocks but not to 100 random stocks but to 5-10 good stocks/Funds.
Ignoring potholes does not save you from falling in one
Mostly investors select an investment avenue/scheme simply because it provides better returns or is recommended by a friend, family member or agent/broker. We are of the view that it is important for you to take responsible investment decisions, and not be influenced merely on the basis of what your friends, family members or agents/brokers say, nor only the basis of mere performance.
Investors should recognize that various investments have varying risk profiles (Risk profiles and investment types will be covered in later articles). For instance, stocks/equity funds have a higher risk profile, while debt is relatively low risk. You must select an investment avenue based on whether it suits your risk profile. For instance, a 55-Yr old who is headed for retirement must not take very exposure towards equity, unless he has already planned and created optimal corpus for his retirement.
Hence, it is imperative to ascertain your willingness to take risk, or else you would be making an incorrect investment decision, as you may be investing in an asset class or an investment avenue which just doesn’t suit your risk profile.
Getting married to your investments
Very often investors get married to their investment portfolio. But this emotional attachment towards your investment portfolio may not be always good to your financial health.
After having formed your investment portfolio in line with your investment objective and appetite for risk, it is vital that you review your portfolio at regular intervals. This will help you not only to identify the duds in your portfolio, but also do a prudent alignment taking into account your investment objectives and risk exposure.
Timing the markets
While many may say that the markets are volatile, and why not play with it; we think that instead of “playing” with the volatility, “managing” volatility can do well for your financial health as well as physical health. How do you do it? Well simple. Adopt the SIP (Systematic Investment Plan) route of investing, as this help you in rupee-cost averaging (which according to Albert Einstein, is the greatest mathematical discovery of all time) and also power your portfolio, with the benefit of compounding. Thus there’s rational in staying invested to meet your financial goals.
Put simply, this implies that risk-taking investors must abandon the temptation to get caught up with market highs and lows. Instead, they must work at regularly setting aside a sum of money and investing the same in line with their risk profiles regardless of market fluctuations. So now it’s time to devise the simplest path to avoid these mistakes and bring some sense in our investment style. Over last few years of my experiments in different strategy of investments the most convenient and simplest thing I came up with is a four step as below:
- Make your plan and know your goals, risk profile as well as saving contribution you can make to meet you goals.
- Based on step 1 devise your portfolio and define the composition based on split between different asset classes Equity(30%), Gold(10%), Debts(20%) and Real estate (40%). (numbers just an example)
- Study about different options in an asset class, select the one suit you and start investing monthly in the same split.
- The most important step Quarterly/Half yearly check the portfolio of assets and realign to planned split. As all sectors will grow/decline at different rates, so it’s better to realign them every quarter or 6 months. For e.g. if equity investments grew by 15% compare to 10% of other investments you will have extra money in equity so you can take it out and split among other classes, in his way you keep en-cashing your gains from one asset class and in vice versa situation buying more units of cheaply available assets.
Now step 1 & 2 are the most boring and toughest one to start with but once completed you will be on the right track. One should be willing to spare few bucks and take help from financial consultants to plan their goals successfully.
Good Article… However, could you please enlighten a lay man to how to identify a good mutual fund scheme/stock.