- Making investments without clear goals: One of the most common mistakes that investors make is not knowing what they are investing for. They should be clear on the financial goals, time horizon and appropriate risk for those goals. Only then can they have an investment strategy that delivers against those goals. While it is not possible to predict how exactly an investment will perform, it is indeed possible to work with a strategy and make it actionable. This also helps in tracking and taking corrective measures when the investment does not go as per the original plan. For instance, insurance is a completely different goal than wealth creation, and hence the choice of instruments for the two needs to be completely different, else you may get stuck with a good insurance product with poor returns.
- Having short investment horizon: Often people begin investing in order to achieve goals that are short term in nature (i.e. 3-5 years, for example, college education for child starting in a few years). Such investors not only lose the opportunity to invest in high return assets (e.g. equities) but also the power of compounding which is fundamental that drives portfolio growth. Compared to this a long term investor (15-20 years) can put their investment in high(er) return assets enjoying compounding growth for many years and hence build greater wealth.
- Not diversifying enough: Diversification is critical to have a healthy portfolio resilient to an adverse fall in any particular company, sector or asset class. It is surprising how many investors do not put adequate focus on diversifying though it is reasonably simple to achieve. One should not invest in only FD, debt or equity but should spread investments across these three, when investing in equities should be oriented towards long term and one should have stocks of companies from all major sectors but not allocate 5-10% to any one stock.
- Not rebalancing over time: Having created a well diversified investment portfolio it is equally important to regularly check back on the portfolio to make sure that composition of the portfolio has not gone out of sync due to market movements. When a particular sector/stock outperforms others, its share in the portfolio increases, exposing the portfolio to relatively higher risk. Hence one should trim positions in suck sector/stocks and buy into other sectors to balance the portfolio as before. This strategy though painful in the short term leads to superior performances in the long term.
- Holding on to a loser to break even: When an investment goes down in value, far too often we see investors who instead of evaluating company performance and deciding if they should sell, do the exact opposite by continuing to hold the investment in the hope that eventually it will recover. Letting pride take over reason and holding to losers without any financial rationale but only to avoid accepting loss is a clear mistake and leads, to rapid erosion of portfolio with time.
- Buying on tips: Another common mistake that a lot of starting investors make is to invest based on tips they receive from friends or family. Typically these tips do not have any supporting research and rational justifying the recommendations, and more often than not they originate from media efforts which can be. Next time you come across such an amazing tip, do not jump to act on it but force yourself to rationally evaluate it – gather all available facts and data and spend time analyzing the opportunity before you invest.
- Letting emotions into decision making: We are emotional beings and hence heavily prone to biases in our decision making. The field of behaviour finance has established that our financial decisions are sometimes guided by our biases rather than logic, which may lead to disastrous investing results. It is easy to get emotionally attached to an investment due to factors external to the business (e.g. a close family member’s association with a company, likeability of the CEO, etc.). Hence when taking investment decisions, one needs to take a hard look at emotions that may be creeping into decision making process. Decisions should be taken based on hard data, facts and critical assessment of the investment opportunity alone.
While there are many other mistakes that an investor can make, recognizing and avoiding the seven listed above will dramatically improve the chances of being successful. There is no single secret to investing and the best thing one can do is plan investments for long term, follow simple investment strategies based on fundamentals, be patient, and avoid emotions ruled decisions. Good luck!