- The journey of building your wealth by investing in various financial instruments is promising. However, since it involves money, you should avoid simple mistakes that can prove costly. It is an obvious point to make, but in the excitement of your first steps into investing, there is a likelihood of making mistakes. Therefore, before you start your journey towards investment glory, keep these common mistakes in mind in order to avoid them:
- Lack of discipline in investing Switching in and out of funds or not holding investments in your chosen funds for long enough can result in not achieving your financial goals. This also is evident in investors attempting to ‘time the markets’- which is waiting for the absolute lowest market level to invest more or waiting for the market peak to withdraw their investment. This may cause a lot of stress as no investor, including professional fund managers in the world, get the market timing all the time. Avoid attempting this and remain focused and disciplined when it comes to investing. Instead, use that time to create a sound financial plan which includes thinking about your financial goals, understanding your risk profile and deciding appropriate asset allocation for yourself. Don’t get swayed by short term market movements and don’t always keep following the market hoping to identify the best time to invest. When it comes to investing, the best time is always ‘RIGHT NOW’!
- Mismatching risk profile and time horizons of investments with those of your financial goals: Before investing, you must assess your risk profile. This is based on your risk capacity (demographics such as your age, income, number of dependents etc.), your risk tolerance (your affinity towards risk) and the level of risk required for you to achieve your goals. Based on this, your risk profile may broadly be ‘High risk’, ‘Medium risk’ or ‘Low risk’. Your resultant asset allocation will be more skewed towards fixed income or debt instruments if you have a lower risk profile while it may be more skewed towards equity if you have a higher risk profile. Also, debt investments are preferred to plan for short term goals since they are low on risk. Since equity investments offer the potential for higher returns over the long term, use them to plan for long term goals such as for building your retirement corpus. So if you make investment choices having taken your risk profile into account and also evaluating the time horizon involved in reaching your financial goals, your decisions would definitely be much smarter.
- Relying solely on recent performance: Top 10 lists based on past 1 or 2 year performance may sound tempting, but be cautious. This philosophy of investing can be a recipe for disaster as past performance does not guarantee future results and more importantly, when it comes to markets, things can change very frequently and securities that performed yesterday may simply not do well tomorrow. Therefore, making investment choices singularly on the basis of short term returns is not a good idea. While short term returns do obviously mean that the product has done well recently, you should also consider returns over multiple time horizons, compare performance against the benchmark and against other similar or comparable products, to take the right decisions. Also check if the fund manager has changed recently and if so, consider his previous track record and his overall investment philosophy.
- Lack of balance in the portfolio: By holding your portfolio in one or few asset types only, your investments will be affected by similar economic indicators or growth drivers. Your portfolio will be too narrow and will not be protected from under-performance or poor returns in that asset class. Think of all your investments being in the equity markets and that the equity markets under-perform for a prolonged period of time. This is a common mistake can be easily avoided by diversifying into investments and asset classes that balance each other out.
- Over-diversification: Now as you’re already aware, Diversification is necessary to reduce the risk you may get exposed to, but if your investments are spread too widely over a number of assets, you will not achieve optimal returns as a whole. Even if you’ve made great returns on a particular investment, it won’t be meaningful to you as it now may be a very small part of your portfolio. Yes, the risks are fewer but over diversifying can also lower your potential to gain higher returns. When it comes to equity mutual funds, for example, avoid the tendency to invest in 10-15 funds as instead of buying a carefully thought-of selection of stocks, you may end up buying small percentages of all the stocks available in the market through the different funds! That’s not very smart, is it?
- Falling prey to get rich quick schemes: Some companies promise returns much more than what’s on offer from other similar companies. You should always assume that when it comes to investing, if something sounds too good to be true, it probably is! Get rich quick schemes should be avoided as they are unlikely to deliver. Even if there’s a small chance they could give you great returns. It always makes sense for you to conduct proper due diligence before investing in these heavily advertised schemes.
- Emotional responses to events leading to impulsive decisions: Very often, our emotions come in the way of sound decision making. When markets fall, a lot of people do the exact opposite of what should actually happen - they redeem their investments and even stop their SIPs in mutual funds as they feel the markets may fall even further, instead of just sticking with their plans or investing more. This is due to the general negative ‘sentiment’ and can lead to lost opportunities. The reverse also happens when markets are rising - people invest a lot of their money when markets are at their peak levels, instead of considering their decisions carefully, due to existing market euphoria. Then there are situations where investors put in money based on what others around them are doing, instead of thinking about what they’re doing first! These decisions are based on emotions and impulses and should be avoided as far as possible. Remember- when it comes to money, just like in life, the best decisions are made when reason is separated from emotion.
- At the end of the day, it’s your own hard earned money so please be smart with it.
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Key Takaways
- While investing in mutual funds can be a fulfilling activity, mistakes can become costly.
- Over dependence on near term performance record is a critical mistake investors make.
- Another common mistake is the attempt to time the markets perfectly.
- Wrong product choices due to mismatched risk profiles and investment horizons are also commonly seen.
- Unbalanced portfolios, poor diversification and asset allocation are other common mistakes investors make.
