Investment is a term frequently used in our day to day life. It can mean savings alone, or savings made through delayed consumption. When an asset is bought or a given amount of money is invested in the bank or any other avenues, there is anticipation that some return will be received from the investment in the future.
Many people invest without effectively learning the investment process or the investment products. Investing without considering what you really want to achieve will end up in losing money. These classes of investors often react to the short-term fluctuations of the markets. Investing is not only about picking some stocks and parking your money, but also about avoiding mistakes.
Mistakes to Avoid While Investing
Retail investors can be better rewarded if they avoid making the following mistakes.
- Don't be unrealistically optimistic
- Don’t show over enthusiasm to trade
- Don’t miss the benefits of compounding of capital
- Don’t worry about the market, think only about the stocks where you have investing
- Market Timings
- Buy in times of panic
- Don’t focus on past performance
- Diversifying too much will kill your investment
- Lack of Reinvestment
- Lack of Diversification
- Emotional Decisions
- Overpaying for Investment Fees
- Not accounting for time horizon
- Frequent trading
- Fear based decisions
1. Don't be unrealistically optimistic
A bull market makes retail investors believe that they are smart - after all, anything they put money into goes up. This overconfidence in their own skills leads to a complete ignorance of the risks involved. Every new generation that invests in the market pay no attention to past experience. These new investors mistakenly believe that stock prices only go up. Don't be overconfident and don't start believing that you have superior expertise compared to the market. Understand that in a bull market you are benefiting because the whole market is going up. If those around you are getting unrealistically optimistic, start managing your risk consequently.
2. Don’t show over enthusiasm to trade
Good batsmen realize that some balls outside the off-stump should be left alone. In the same way, professional investors realize that sometimes it is better to just stand still than to rush into a stock. Retail investors repeatedly make the mistake of "flashing outside the off-stump" because they cannot defend against the temptation to trade in every opportunity. And, like an inexperienced batsman, they suffer the same destiny. Too much trading will lead to a lot of issues like, extra commissions to your broker, huge tax implications, etc. Some of the world's best investors follow a buy and hold strategy it will work well for you also.
3. Don’t miss the benefits of compounding of capital
Retail investors ignore this basic concept of compounding. Compounding of capital can benefit you only if you leave your money uninterrupted for a long period of time. The earlier you start investing, the bigger the pool of capital you will end up with for your middle-aged and retirement years. Don't wait to start investing only when you have a large amount of money to put to work. Start early, even if it is with a small amount. Wait this to grow to a very large amount with the passage of time.
4. Don’t worry about the market, think only about the stocks where you have invested
Don't worry about the direction of the market, worry only about the business prospects of the companies whose stocks you own. Retail investors are passionate with the question "Where do you think the market will go?" This is a wrong question to ask. In fact, no one knows the answer. The right question to ask is whether the company, whose stock you are buying, is going to be a much bigger business 10 years from now or not? Don't take a view on the market; take a view on long-term industry trends and how the chosen companies can create value by utilizing these trends.
5. Market Timings
It is very difficult to time the market, at the same time it is very important also, so be smart enough to buy at the absolute bottom and sell at the absolute top. Some investors get wind of success stories from investors and traders who win big time by timing the markets. Even though market timing can turn out to be successful for a lot of investors, many investors make the mistake of investing into a stock while its price is increasing instead of at the lower level. Another market timing mistake is selling an investment when the investor thinks that the stock is about to come down, potentially causing the investor to lose capital growth opportunities if the stock does not in fact drop-off as expected. Though market timing is a winning strategy for many investors, it can be a risky investment strategy and is not recommended for most investors.
6. Buy in times of panic
The best time to buy a stock is when the markets are falling and there is a fear in the minds of investors. But most of the retail investors do exactly the opposite. They sell when the markets are falling and buy when the markets are high. This will cause them to end up with losing twice - by selling low and buying high. If nothing has changed about the long-term outlook for the company that you own, then you need not sell this company's stock. Use this opportunity to buy more of the same stock in falling markets.
7. Don’t focus on past performance
Don’t focus much on the past performance; it is like driving forward while looking backwards. It is a very common perception that because a stock has done well in the past one year, it is the best stock to invest in. Retail investors do not realize that often the best performing shares will underperform the market in the future because they are already overpriced. Don't go after hot sectors that are currently giving high returns. Look forward to see whether the gains produced in the past can get repeated or not. Always remember short-term trends of the past might not get repeated in the future.
8. Lack of Reinvestment
Whenever an investor is to sell off their investments, a biggest mistake that can be made is to not reinvest the money into a different stock, therefore holding the proceeds in cash. In many cases, it is advisable to reinvest the income into another stock that meets the investor's own objectives. Another reinvestment error happens when investors fail to take advantage of the opportunity that a lot of investments offer the ability to reinvest dividends. This is a good strategy for wealth building and should be considered by all the investors.
9. Lack of Diversification
Diversification is one among the fundamental rules to a prosperous investment portfolio. Most of investors neglect to properly diversify their investments address this step. Whenever an investor decides to invest into a particular industry, sector or into a particular company without diversifying across other investments, they are fundamentally putting all of their eggs into one basket. This move can considerably add to the investor's portfolio risk and the possibility of losing capital is very high in this.
10. Don’t take Emotional Decisions
Don't be led by emotions, most of the investors make their trading decisions on an emotional basis, rather than on a logical basis. Emotional investors will sell off their investment when the market price is dropping and buy when the price is going up. Although the fundamental investment goal is to buy when low and sell when high, a lot of investors execute the exact opposite strategy based on their emotional reactions.
11. Don’t pay too much as Investment Fees
The price that is paid for investments can have a huge impact on an investor's total investment return. Consider investment trading fees, investment transaction fees and up front prices for investment advice in order to ensure that your net investment returns are as healthy as possible. Aim to pay no more than 2% per trade in commissions. So if you're buying Rs50000 of stock, you'll want to pay a maximum of Rs.1000. Fortunately, there are a lot of brokerages with modest commission fees. Dealing with a broker who charges less commission will help you to earn more return from the market.
12. Not accounting for time horizon
The type of asset in which you invest must be chosen based upon your time frame. Despite of your age, if you have capital that you will need in a short period of time (one or two years, for example), you should not invest your money in the stock market or equity based mutual funds. Even though these types of investments offer the greatest chance for long-term wealth building, they frequently fail to generate profit in short-term. Similarly, if your horizon is greater than ten years, it makes no sense for you to invest a majority of your funds in bonds or fixed income investments unless you believe the stock market is grossly overvalued.
13. Frequent trading
A trader is one who buys a company’s stock because he expects the stock to jump in price, at which point he will quickly dump it and move on to his next target because it is not attached to the economics of a company, but rather chance and human emotion. But when you invest, your wealth is tied to the fortune of the company. You are a part-owner of a business; as the company prospers, so do you. Hence, the investor who takes the time to select a great company has to do nothing more than sit back, develop a rupee cost averaging plan, enroll in the dividend reinvestment program and live his life. Frequent trading neither helps the economy nor the investor.
14. Diversifying too much will kill your investment
Beyond a point, having too many stocks in a portfolio can be of negative impact. Over-diversification can upset your portfolio, especially when you have not done enough research on all the companies you have invested in. If you are an active investor in the stock market, maintain a manageable portfolio of 15-25 names. In the long-run, this will produce better returns for you than adding another 20 names to your portfolio.
15. Fear based decisions
The simple formula of making profit in the stock market is "buy low and sell high". But in practice, only a small number of investors do it. In case the market or share price is coming down, instead of staying around and buying up the stock for very less price, panic and selling off is happening. True money is made only when you, as an investor, are willing to sit down in the empty room that everyone else has left, and wait until they recognize the value they left behind. When they do come back, you will be holding all of the shares. Your patience will be rewarded with huge profit and you will be considered "brilliant".