You must avoid making financial mistakes if you want to create through investing. Minimising investing errors will help you stay profitable in the long run. This article will cover some of the common investing mistakes that most of us often make and are easy to avoid.
Having no investment plan
Even before you invest the first rupee, it is vital to have an investment plan. Most of us are guilty of investing without a plan or long term view. Often we take investment advice from friends or colleagues without analysing whether it fits in our investment plans.
Before you invest, you need to decide your long and short term investment goals and choose investment tools accordingly. Secondly, you need to determine how much you must invest, based on the horizon, to achieve your goals.
Of course, if your investment goals are short-term, you will invest less in stocks and more in debt funds. Conversely, while investing for a long term investment horizon, you will allocate more funds in equity investment.
Finally, you need to decide whether you want to do it yourself or choose mutual fund investing, which lets you invest in a pooled fund.
Not rebalancing your portfolio
Rebalancing means adjusting your portfolio per risk and returns. Portfolio rebalancing is a critical practice that helps you manage the risk and return of your portfolio. It enables you to keep returns on your portfolio unaffected when one asset class is underperforming.
There are numerous ways one can rebalance a portfolio based on the ultimate investment objective. It involves readjusting the weight of each asset class in the portfolio to optimise returns. You can confirm a target percentage and once or twice in a year sell assets above the target percentage and purchase those below the cut-off.
It is not a difficult task. But if you don’t rebalance, you may end up taking more market risks in one asset over time than you should.
Not diversifying enough
Portfolio diversification is the most common advice that financial advisors will give you. The aim is to lower exposure in any asset and diversify risk into multiple asset classes based on a target percentage.
Sometimes investors make the mistake of buying stocks of multiple companies across sectors. But it is not diversification. Portfolio diversification essentially means purchasing different asset classes seemingly unrelated to each other. This way, one can ensure that when returns on one asset dwindle due to market conditions, it doesn’t impact the overall profitability of the portfolio.
Too much diversification
Too much diversification can also lower final returns and cause your investment to underperform. Investing in too many asset classes can dilute your potential to earn returns while one asset class performs exceptionally well.
For example, buying multiple asset classes from the same asset category or style neither helps in diversification nor improves risk exposure in that category. Instead, it makes managing your portfolio more complex and increases investment costs.
Chasing investment performance
Some investors always try to beat the market, and it causes them to make costly mistakes. In the long run, it is tough to generate above-average returns constantly. Investors need to select stocks that will perform in the long run instead of following recent market trends.
Above-average performance by stocks is temporary, often resulting from a market fad or trend. However, historically, market returns always fell back to follow the benchmark index, and you should be comparing performance against it.
Also, an asset generating market-beating returns associates more risk.
Check the fees you pay
The fees that you pay on trading will eventually result in lesser returns on your investment.
Since the expense fees vary widely across the industry, you need to evaluate all aspects carefully while selecting a financial advisor.
Reviewing investment costs includes knowing fees paid to investment advisors, transaction fees, or commission paid on the individual investment.
Besides ordinary expenses, the total cost of investment can also include mutual fund or ETF expense ratio, custodian fees, broker-deal transaction fees, charges paid to the government, taxes, annual maintenance fees, and more.
Know More About What is Expense Ratio in Mutual Funds?
Not controlling factors that you can
When it comes to stock market investment, you can’t control market movement. But there are factors that you can, which includes,
- Controlling expenses and fees by finding competitive AMC
- Deciding minimum investment amount
- Setting risk and return levels during individual investments
- Handling taxes
Investing total corpus in a single investment option
Many times investors are guilty of not diversifying their portfolios effectively to balance risk. Either they invest too much in mutual funds, individual company stocks, or stocks of companies where they work.
A rule of thumb suggests not allotting more than 5 percent of the total investable corpus in one single investment. Not diversifying is one critical mistake you can’t afford.
Ignoring tax implications
Tax is a critical factor that affects the final returns on your investment. Keeping it at a minimum would mean more money in your pocket.
Investment in the money market is subject to capital gain tax – long or short term, depending on the duration of the investment period. Short term capital gain is taxed at a higher rate than long term gains. Also, tax rates vary based on the type of assets, such as equities, gold, or debt. Besides, every trade that you carry out in your Demat also attracts specific government fees, like GST, stamp duty, and such.
While one can’t avoid paying taxes on certain occasions, focusing too much on tax can also damage financial growth. So, while rebalancing, don’t focus too much on tax. But at the same time, try not to incur any short-term gains since short-term capital gains attract a higher tax rate. Put your funds into long term capital gain funds to reduce the tax rate and earn good returns over time.
While you are investing, especially in equities, have a long term horizon. Historically, stock investment has successfully beaten returns from all other asset classes in the long run. And since no one can predict the market correctly in the short run, it makes it nearly impossible to win with short-term investment.
Therefore, while investing in stocks, always invest with an expanded horizon regularly and allow your portfolio time to recover from any market decline.
Avoid investment biases
Well, there is an entire chapter on investor’s psychology that talks about biases.
Investors as human beings are not free from making emotional errors. Typically, the more you depend on emotional judgement while investing, the more are your chances of losing. Emotion and investment are like oil and water, and sentiments prevent investors from making sound decisions.
If you think you can’t handle investment without being emotional, hire a financial advisor who can do it for you. The financial advisor will function as a circuit breaker between emotion and the market.
The value investors often stay invested in single stocks for a long time. Reasons? The market tends to perform in the long run. Since no one can correctly predict when the market will break out or reconcile, long term investments generate more value. Besides this, every time you trade, it attracts transaction fees and other expenses, increasing the total cost of investing.
Hiring the wrong financial advisor
You can jeopardise your investment goals by hiring the wrong financial advisors without looking at their credentials or track records. There are various types of agents out there to offer financial advice, and hence, you need to select the one who suits your needs carefully. For instance, if you are a new investor, choosing a full-time broker offers more advantages.
Not opting for SIP
A systematic investment plan is an approach that allows you to invest a fixed amount regularly in the market. SIP allows you the benefit of rupee cost averaging and helps your investment grow at a compounding rate.
If you don’t opt for SIP, the other option is investing a lump sum, which requires you to time the market correctly. However, both options need proper financial planning to succeed.
Chasing a hot stock, idea, or industry without understanding
It is the same as emotional biases that we have talked about above. Basing your investment decision on other’s judgement can lead to a colossal blunder. Hence, always pick stocks that are fundamental robust and sectors you know would perform in the long run.
You may get lucky once or twice in chasing hot stocks, but you can’t do it constantly.
Not following a single investment philosophy
It is often a result of poor investment planning. Sometimes a mixture of two types of investment philosophies results when you invest without a strategy, like combining passive and actively managed funds in your portfolio. It is called the ‘core and explore’ or ‘core or satellite’ strategy. While some may consider it a good approach, maintaining both investments, in the long run, becomes cumbersome and requires investors to time the market to invest according to the fund’s performance.
For the best result, keep your investment strategy simple.
All these mistakes may not apply to you. But even then, if you can avoid making any single mistake, consider it an outstanding achievement, and you will see your investment moving in the right direction. However, never avoid investing as it is essential to build wealth for the future. During investment planning, analyse financial needs, horizon, investable amount, and tax requirements in advance. Take the help of a professional if you can’t do it alone.