It is the illusion of easy money to be made while playing in asset classes such as stocks, real estate, equities and commodities, among others that make investors commit serious blunders bringing them closer to financial ruin. Here are some common blunders investors commit when investing:
Investing on tips
Although investing on tips may seem like the easiest way of making money, it is not always the most reliable way. There is a possibility that the individual giving away the tips may have vested interests, and might be making money at your expense. Relying on tips blindly without knowing its background can potentially bleed one’s investments.
Investing without understanding the basics of the instrument
Most investors commit the mistake of not fully understanding the nuances of the financial instrument, its working and time horizons—investing is best done over the long haul to fulfil financial goals. For any investment with a longer time frame, understanding the fundamentals of that instrument becomes extremely critical. Fundamentals for any asset would mean evaluating the workings, costs and the liquidity in the instrument.
Investing in the past and not in the future
Investments should always be based on the future outlook and dynamics of a particular issue, and not solely based on past performance. A company or a fund that has performed well historically may or may not be able to sustain similar growth levels and performance as shown in the past. A good example of this is the infrastructure sector where investors who entered as late as 2007 by looking at past performance would have been badly bruised till date.
Investing without having enough liquidity to meet regular expenses
At times, euphoria and market sentiments get the better of us. In such scenarios, stretching your finances and putting oneself in liquidity crunch may not be the best way to go. It is imperative that investors keep enough money in safe and liquid instruments to meet their daily expenses and contingencies. Moreover, investors should avoid taking costly loans and piling leverage to invest in financial markets, given their unpredictable nature.
Investing without understanding one’s risk taking ability
Most investors invest based on the flavour of the season, rather than their risk taking willingness and ability. This often leads to investors investing either too aggressively or conservatively, depending on the prevalent market sentiment and scenario. More often than not, this leads to unexpected losses in the portfolios, sometimes in the form of opportunity costs. Investors should have a financial plan based on their risk profile to ensure that they meet their goals, and they should stick with it through thick-and-thin.
Concentration risk
Investors should avoid placing all eggs in one basket. Diversification forms the crux to reduce concentration risk, as high exposure to any single asset class can severely affect one’s investments in a downturn. Just merely spreading one’s wealth over many asset classes isn’t enough—investors should diversify their investments across un-correlated or negatively correlated asset classes, as any loss in one or more asset classes can be set-off by the gains in other assets.
Portfolio churn
Investing is a long-term game and hence investments should always be made over the long haul. Contradictory to this thought, investors often receive frequent/short-term recommendations from their broker/advisors. Investors should note that the brokers/financial advisors could have vested interests to generate revenue through brokerage. After all, a broker/financial advisor earns money whenever you trade – irrespective of whether you buy or sell, and also irrespective of whether you made a loss or a gain. Even if you made good returns in the last 2-3 years following your broker/financial advisor’s recommendations, it may be worthwhile analysing whether the trades played any part; or whether it was simply the stock market’s stellar performance. In case of the latter, investors might as well have sat pretty on a few blue-chip holdings and earned much higher returns by saving on brokerage.
Timing the market
Lastly, timing the market can result in unexpected losses. Even the best of the investors across the globe like Warren Buffet have admitted to not being able to time the market. Investments are the safest when it is done for the long haul. Although most investors believe they would have a better opportunity to buy after a market correction, few eventually realise that it is easier said than done.