Often it is stated that investing is simple but not easy. However, the problem is that people think it is the other way round and end up making some common mistakes. To keep investing simple, it is important to understand that one must try to avoid a few mistakes – usually avoided through common sense. Unfortunately the Common Sense is usually uncommon. Let us understand a few of the common mistakes a layman makes that eventually destroys their financial lives. The factors we are mentioning may look very simple and that is why most of the investors ignore those factors.
Buying Insurance as Investment
In investing, it is important to understand the difference between – what an investment asset is and what is an amount paid to keep it for emergencies or safety. To put it in a right perspective, while cash is one way to be kept for emergencies, insurance is another way. There are different types of insurance like mediclaim, term plan and even a few complicated unit linked insurance plans (ULIP). Remember the insurance policies are for safety purposes. However, the issue is a few people buy insurance policies as investment ideas. ULIPs are one such investment. It is true that ULIP may turn profitable in the long run, but surely not at the CAGR provided by the other asset classes taking similar kinds of Risk. Remember, buying insurance policies for investment purposes is a wrong idea! If you have invested your money in an insurance plan to get a return in future, it is a huge mistake! Another factor is, most of the people are over insured. Those who are in Service in the Corporate Sector, have group policies and then also take further insurance policies. The payouts at the time of Claim are much lower in such cases as compared to the premium paid. So the first factor that goes wrong is – buying insurance for investment.
Unable to Understand the Credit Card Mystery
After reading the heading, one may feel – What is the relation of Credit card and investment. However Credit Cards is a plastic money and every penny we spend on Credit cards has got some relation with investing. So, another common mistake one makes is the over usage of a credit card! This habit not only affects the investment journey but also affects their own credit score if not maintained well. The basic idea of the equation of investment is as
Income – saving = Expenses
Or as we can put is as follows
Income – Investment = Expenses
However, the spending by using credit cards is sometimes higher owing to different offers being given on the credit cards. Many times we spend on the things which are not needed or required. And though the amount spent through Credit card has to be paid later, this eventually leads to overspending. Then there are certain people where they try to pay the minimum amount on Monthly basis – that leads to a debt trap in certain Cases. Further, very few people really enjoy the benefits like free lounge access, buy one get one movie ticket, etc. To sum up – habits of over spending through credit Cards, not utilising the core benefits of cards and paying higher interest rate on non-paid amounts leads to lower investing eventually. Understand the credit card mystery and it helps in generating returns.
Ignoring the Idea of Compounding
As for the purpose of mathematical formulas, almost everyone has come across the basic formula of compounding. But knowing something and implementing it practically are two different things. So, very few people really understand its power and only a few use it while investing. This is where people do not start saving early and hence lose out on the benefits of compounding. Starting early gives a compounding advantage to investment. Always remember compounding occurs over a long period of time. However the problem is nowadays investing has turned into trading and compounding hardly takes place. Compounding is the eighth wonder and hence we must focus on the same. Percentage returns is what everyone looks at in the short Term. But for Compounding impact reinvestment and consistency of returns is important. Most on the street ignore the basic idea of compounding.
Depending on stock tips and investing without proper knowledge
Many investors depend on stock tips from experts in the field. We wonder why someone would give recommendations to others. We feel if someone is so good at it, the person should invest himself and generate returns. One will find a lot ‘so-called experts’ giving stock tips over different social media networks. Unfortunately, a lot of people fall in a trap of these people and invest money without any knowledge. The result is such people only lose money and then never turn up to market ever. Mostly, the small retail investors suffer such challenges and only feel that equity markets are not a good place for investment. We reiterate that those who hardly understand the equity markets, mutual funds are a better way of investing. Please remember, social networking sites would be the last thing one should look at while starting an investment journey.
Falling Prey to Lifestyle Inflation
Everyone likes to upgrade themselves in life. But it should be a gradual move. However, with finances nowadays available at fingertips and exotic lifestyles visible on social media, such moves have been quicker than expected. Remember, such spending from the future has an additional cost to it. Moving to a larger living space, upgrading a car (regularly through future income) are some of the examples of lifestyle inflation destroying financial lives. Add to that the unnecessary spending on the regular sale happening through e-commerce sites, the unnecessary spending only rises.
Ignoring Emergency Budgets
Very few people keep a track of their expenses. Most of them just don’t know where the money is gone. One must understand what income they have, then plan for the investment amount and accordingly plan for expenses. In some cases, a few forget to make an emergency budget as well.
Not making financial plan or setting a financial goal
At the start of the article only we had categorically stated that making a financial goal is the basic idea of investing. Answering the three important questions like how much money is required, When it is required and For what it is required gives us a financial goal. People do not know why they need to save money because they don’t know their financial goals. In our blogs on how to set financial goals, one would understand in detail why it is important to set financial goals.
Diversification is the key to safety for a draw down. It is stated that fortunes are made by investing in a one multibagger. But then even the misfortunes also happen by investing in one single asset. Some people would invest all their money in real estate, some would invest all the money in gold, some would just keep it in the locker and some would invest all the money in the stock market. Very few people understand the right way of diversifying the investments. Diversification can happen in different asset classes like proportionate investment in gold, realty and equity. In equity also further diversification is possible in different sectors and stocks. Diversification at lowest cost is possible in mutual funds investments. As one can diversify at just Rs 5000 in mutual funds by holding units. There are some who avoid financial investment as they feel it is complex. However, the financial assets are the most regulated markets and very liquid ones.
Lack of Patience – Hold Your Winners
It is stated that it is easy to buy and easier to sell – however it is very difficult to hold on to the investment. Investment is all about being patient and holding on to your winners. Remember, the longer the duration of investment the better the returns would be as compounding happens. However, the problem is investors can’t wait for their wealth to grow. People join equity markets reading fancy stories of wealth creation and try to double investments in no time. With the availability of instruments like Future and Options (F&O) the leverage factors come into play and many lose huge chunks in no time. F&O are hedging instruments and few newcomers use it for speculating. They eventually get greedy and that leads to mistakes.