It’s common and human to make mistakes while making investment decisions. One shouldn’t take it to heart and move on. Learning from mistakes is an important element in life as well as in investing.
“Every great money manager I've ever met, all they want to talk about is their mistakes. There's a great humility there.” — Stanley Druckenmiller
As financial assets fluctuate in value, one should conduct due diligence and make informed decisions as opposed to instinct or emotions. So, what are the common mistakes which people make while investing? Let's find out.
1. Investing without understanding
One should not invest without understanding the intricacies of any financial product. All financial assets have different risk return parameters.Most often investors gravitate towards the hottest industry (like metals currently) or the in-thing (like cryptocurrency). They may noy understand the specific business but believe they would make a killing as the prices have moved up significantly in the short term.
2. Lack of Patience / Short term focus
Most asset classes need a long term approach in order to generate good returns. You need to patiently meander through the various up and down cycles. $25 invested in bitcoin when it started trading in 2010 would have made you a millionaire today. Rs 20,000 invested in the Sensex in 1979 would have made you a crorepati today. Wealth generation takes time and requires patience. Compounding makes investing profitable but it needs time to work.
3. High Investment Turnover
Too much chopping, churning and / or changing your portfolio kills the returns. Your brokerages and fees are high as you incur costs on both legs (buying and selling). Further, short term capital gain tax is higher than long term capital gain tax in most cases. Then there is also the opportunity cost of missing out on long term gains. So, give your portfolio some time. Monitoring is important, but daily avoidable.
4. Attempting to Time the Market
“Timing the market is a fool's game, whereas the time in the market is your greatest natural advantage.” — Nick Murray
Any attempts to catch the bottom or tops can be quite frustrating. In this process people can lose money or not invest at all while waiting for the right opportunity. Investors should be willing to sacrifice some profits due to late entry or early exit. This is why SIPs are useful as they bring in financial discipline and average out the cost of purchase, eliminating timing distortions to some extent .
5. Putting all eggs in one basket
Diversification is one of the key principles in investing. This strategy helps to minimize volatility and maximize returns. There are two ways to diversify - one is by investing across asset classes like equities, bonds, gold, real estate, crypto etc. When equity markets are down, bonds and gold may go up thus providing a cushion. Another way to diversify is by broadening investments within the same asset class. So instead of investing all your money in one stock, you can have a portfolio of 25-30 stocks which would minimize risks.
6. Letting Your Emotions / Biases Rule
“If you can’t control your emotions, you can’t control your money.” — Warren Buffet
Many times we get emotionally attached to our investments and refuse to objectively make decisions to buy / hold / sell. People become fearful when the market nears bottom or greedy when markets nears tops. Very often our decisions are influenced by behavioural biases in the decision maker, which leads to less than optimal choices being made.
7. Refusal to cut losses
“If you have made a mistake, cut your losses as quickly as possible.” — Bernard Baruch
The fear of losses leads to inaction. Studies show that the pain of loss is twice as strong as the pleasure they felt at a gain of a similar magnitude. Investors prefer to do nothing despite information and analysis favouring a particular action that in the mind of the investor may lead to a loss. Holding on to losing stocks are manifestations of this bias.
8. Unrealistic expectations
This normally comes when you have witnessed a Black Swan event like markets doubling from last year and expect it to deliver similar returns year after year. If you haven’t started investing early, the number of years you can earn and thus save is lowered. In such cases, you need to earn astronomical returns to generate retirement corpus or meet other milestone goals. And then you get drawn to dubious products, ponzi schemes which promise you the moon and then dump you.
9. Following the Crowd
Also referred to as herd mentality, this is an outcome of uncertainty and a belief that others may have better information, which leads investors to follow investment decisions which others make. Such choices may seem right and even be justified by short term performance, but often lead to bubbles and crashes. Such investors keep watching other participants in the markets for confirmation and end up entering when the markets are overheated and poised for correction.
10. Learning from Wrong Places
There is a lot of information available on the internet. Many experts constantly come on TV channels and give their opinion which may or may not turn out to be true. Many anchors of business news channels are also influencers. However, there have been instances of insider trading against a few of them. You shouldn’t blindly follow their advice. You should do your own research. You could also take the help of SEBI registered investment advisors.
To sum up, as Morgan Housel says, “Money relies more on psychology than finance.” Be aware of these mistakes which are common and then try to avoid committing the same.