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Common Investor Mistakes And How to avoid them

, September 28, 2015, 0 Comments

common-investors-mistakes-marketexpress-inThere are loads of mistakes that we do in our financial journey. Most of them are common mistakes. These mistakes can be avoided if we know what they are.

Below is the list of few mistakes that are common across most of the investors:

  1. Getting carried away by reading popular blogs and books. In India, Subramoney and Freefincal are few of the most popular blogs on personal finance. Read them, by heart all those things if needed but do not get carried away.

Subra is the advocate of direct equity and Pattu is an ardent mutual fund investor. Reading both the blogs (religiously) does not mean that you are the master of both direct equity and mutual funds. Subra has been in the market for last 20-30 years. He is like Bhishma Pitamaha. He has seen all the seasons, all the people, all the mistakes, all the investment vehicles and tons and tons of balance sheets. You simply cannot copy his portfolio. He has revealed his stock holdings, many times. However, it has been with him for such a long time that you cannot even guess the average price of his holding.

Pattu is an IIT professor and that too with a special liking for physics and mathematics. He has a profound understanding of standard deviation. Again, do not simply copy his portfolio. You do not know his earning capacity, his expenses and hence his risk taking ability or ability to withstand standard deviation.

  1. Over analysis: The gurus call it as analysis paralysis! This is a pure psychological factor working against you.

Let us take an example of selecting a mutual fund and how this ‘over-analysis’ affects us. Say we shortlist 3-4 mutual funds. Then the process is to compare all these shortlisted mutual funds on various parameters and finally select one of them. Those who do over analysis are not happy with  few parameters. They want all the parameters to satisfy their requirement before selecting a fund. Example: They want the one which has a highest alpha, lowest expense ratio and with a famous AMC or fund manager. We are not ready to compromise on any single parameter. This leads to procrastination and ultimately no investment. People start their search/research again. They ask questions on forums. While asking, they are not ready to divulge more details or for open debate. Hence, they get half-baked answers.

  1. Asking advice from too many people. I remember this case. This guy approached a financial planner. The planner gave him a plan and list of investment and insurance products. Then this guy came on a forum and asked a second opinion on the plan. Obviously he got varied answers. Everybody has a different thought process. Example: A FP may suggest blue-chip fund from Franklin. However, somebody may say that alpha is less than the HDFC opportunity fund. The FP, while preparing the plan, must have considered his client’s ability to stomach volatility and hence may have suggested sticking with blue-chip fund instead of mid-cap funds. If you have researched enough about the advisor, stick with his advice. Everybody will have different opinions.
  2. Not knowing what is a conflict of interest. Say, you attend an AMC meeting. The AMC says, “if you are risk averse (everybody is!), please stick only with our recently launched fund of funds. We invest in diversified manner”. Here, what they do not tell you is the underlying funds are also of the same AMC! I think (not sure)*, Quantum FOF has a mandate of not investing in its own funds.

*- This is not to give a direct fund name. Research and then select.

Another example: A FP advises to choose one particular AMC only. This may be due to higher trail commission for him.

  1. Relying on the news channel and papers for financial advice (for that matter, any advice). Say, you are investing in X fund. This fund had 5* ratings when you started investment (just a co-incidence). Now the people on TV say that this is a 2* fund and stay away. You immediately log on to the AMC website and switch to some to some other fund. We must understand that the star ratings are calculated on last quarter’s performance. The long-term investor should not worry about few quarter performance.
  2. Buying or selling investments on their whim. These are the knee-jerk reactions that people do when they are exposed to a certain piece of information.  A classic example of this is recent redemptions from the IDFC premier equity fund. As soon as there was news that Kenneth is leaving IDFC PEQ fund, there were many people who either redeemed or stopped SIP in that fund. These are the knee-jerk reactions that we must avoid. We can wait at least a few months to see if the news is true and who is the new fund manager. Almost, all of the time, the AMC has a process defined for investments. So even if one fund manager exits, the process still is in place. The performance may drop or rise by some percent. Besides, we have no guarantee that the new fund that we are purchasing will have the same fund manager till we achieve our goals.
  3. Not tagging the goals with your investments. The problem with not tagging your goals with investments is that you are not sure when to exit from the investment. Example: you are doing SIP for a  child’s education which is 15 years from now. Here, you can be sure that you need to exit from this fund in next 8, 10 or 12 years (whenever market permits).
    However, if you had not tagged it with goal, you would simply wait for more and more returns. In the process, you may encounter a bear market and the money would not be available to you. Also, managing investments become easier if you have a goal tagged around it. Tagging lets you know why are you investing and where are you investing and for that.
  4. Not understanding what is diversification in mutual funds. Diversification implies spreading your investments across various funds so that your risk goes down.

Example: Instead of putting all your money in infrastructure funds, you can split the corpus in other sectors like power, FMCG or pharma. This ensures that even if one of the sector performs poorly, your overall portfolio is still giving you good returns.

Another example: Instead of being completely in mid-cap, divide the money in large cap and mid cap funds.

However, what people do is, they ‘diversify’ their money in different AMCS. Nothing wrong with diversification in AMCs, but they do not select different categories of the fund while going for another AMC. Buying Franklin mid cap and HDFC mid cap is not diversification. If mid cap collapses, the portfolio collapses.

  1. Extremely high expectations. People expect way too much of the mutual funds. On an average, people expect minimum 20-25% of the equity mutual funds. These kinds of returns are true only for a particular year or for a short duration of time. If you can time the market, wonderful. If not, you will probably have to live with the consolidated returns over a long period of time. The gurus expect 10-12% of returns from the equity mutual funds. You can be a little more optimistic and use a maximum of 14% returns for calculations.
  2. No debt portfolio. People who must have started in a bear market or sideways market (like in 2012 or 2013) would have seen a huge bump on their investments (more than 25%). Overwhelmed by such returns, people may pump all their money in equity mutual funds expecting similar returns on a yearly basis. This is a critical mistake to avoid. Debt portfolio gives a cushion to remain peaceful during the turbulent market. You have the liberty, not to withdraw from the market if the markets are down.
  3. Unnecessary rebalancing. Suppose, you started in 2012. Come 2014 and you are sitting on 20-25% gains. Your goal is to invest for your retirement in 60-40 ratio of equity and debt. This bump shifts your equity allocation from 60 to almost 80%. What do you do? Rebalance? Of-course not. Retirement accumulation would be for 20 years minimum, if not more. Besides, you have just started and the kitty would be too little to have any significant impact on your portfolio in the long run. Unless you are 10 years away from goal or you have serious money in the market (like 70% of the goal amount), rebalancing does not make any sense.

There could be more points, but 11 is a good number to start off.

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