Article

Mistakes to Avoid in Making Investment Decisions

22 Aug 2019

There are a whole lot of investment mistakes we tend to commit inadvertently. The idea is not that you don’t understand these mistakes, but just that you tend to overlook the same. Here are few tips on how to invest in share market while avoiding the common investment mistakes that you must consciously avoid.

Chasing too many stocks to buy

When you talk of a large unwieldy portfolio, we are normally reminded of the Morgan Stanley Growth Fund in 1994, which started off creating a mutual fund investment portfolio of nearly 450 stocks. When you either own too many stocks or try to track too many stocks you end up dissipating energies without adequate returns. Also, stocks help you in diversification only when you diversify across 12-15 stocks. Beyond that it is just risk substitution. Have a universe of around 30-40 stocks and don’t own more than 15 stocks at any point. Even for your mutual fund investment, you should restrict to 3-5 funds to ensure that you don’t over diversify.

Falling in love with a stock that you have owned for long

Falling in love with the stocks you own is a common problem in portfolio creation. Having identified a stock after a lot of effort and after the stock has given you returns for 4-5 years; investors refuse to accept that sector has structurally changed. We have seen such instances in blue chips like SBI, Sun Pharma and Tata Motors. When you fall in love with a stock either due to historical reasons or due to pedigree of the stock, you may end up ignoring the reality of the situation. Also be open about buying stocks where you have booked a loss. A bad decision does not mean that the stock is bad.

Buying without reference to your risk capacity

When we talk of risk capacity, it has a risk angle and also a time angle. Equities tend to outperform other asset classes over the longer term but in the shorter term they could underperform due to volatility. Buying a high beta stock when you have a low risk appetite is a classic blunder. Similarly, buying a stock hoping that it will give you returns in the next 1 year can also leave you disappointed.

Trying to time the market to catch the highs and lows

When you are investing don’t try to time the market. Buying at the bottom and selling at the top looks quite classy but it rarely happens in the real world. There are two problems with timing the market. Firstly, even the best of traders are not able to consistently catch the lows and the highs of the market. Secondly, the incremental benefit you gain by timing the market is almost negligible. In fact, by trying to time the market you end up overtrading and increasing your cost as well as losing opportunities.

Focusing too much on the past while investing

There is a joke in Wall Street that if investing was all about the past then historians and archaeologists would be the most successful investors in the world. Investing is all about the future and that is what you need to focus on. At best, the past can be a guide to your investments but you cannot predicate your investment decisions purely based on what has already happened. This logic also applies to your investment performance. Don’t focus on the performance of the past. Learn from your mistakes and just move on.

Diversifying without reference to correlations

While creating your portfolio, you need to spread your risk across sectors, across themes and even across asset classes. Putting all your eggs in one basket has never been a good idea. It, perhaps, never will be! But then how to invest in share market that your portfolio is diversified? The answer is to buy assets with low correlation. For example, if you own a banking stock and add an NBFC stock to your portfolio, then you are not diversifying because both the stocks are rate sensitive.

Not reviewing your portfolio regularly

It is not just enough to create a portfolio but you also need to regularly review the portfolio. Review your portfolio based on changing equity valuations, shifting macros, changing interest rates etc. Apart from the external review, also review the investments internally with reference to your return expectations, your long term goals and your risk appetite.

Avoiding these mistakes may not make you a millionaire. At least, it will give you a better investment experience. 

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Mistakes to Avoid in Making Investment Decisions

22 Aug 2019

There are a whole lot of investment mistakes we tend to commit inadvertently. The idea is not that you don’t understand these mistakes, but just that you tend to overlook the same. Here are few tips on how to invest in share market while avoiding the common investment mistakes that you must consciously avoid.

Chasing too many stocks to buy

When you talk of a large unwieldy portfolio, we are normally reminded of the Morgan Stanley Growth Fund in 1994, which started off creating a mutual fund investment portfolio of nearly 450 stocks. When you either own too many stocks or try to track too many stocks you end up dissipating energies without adequate returns. Also, stocks help you in diversification only when you diversify across 12-15 stocks. Beyond that it is just risk substitution. Have a universe of around 30-40 stocks and don’t own more than 15 stocks at any point. Even for your mutual fund investment, you should restrict to 3-5 funds to ensure that you don’t over diversify.

Falling in love with a stock that you have owned for long

Falling in love with the stocks you own is a common problem in portfolio creation. Having identified a stock after a lot of effort and after the stock has given you returns for 4-5 years; investors refuse to accept that sector has structurally changed. We have seen such instances in blue chips like SBI, Sun Pharma and Tata Motors. When you fall in love with a stock either due to historical reasons or due to pedigree of the stock, you may end up ignoring the reality of the situation. Also be open about buying stocks where you have booked a loss. A bad decision does not mean that the stock is bad.

Buying without reference to your risk capacity

When we talk of risk capacity, it has a risk angle and also a time angle. Equities tend to outperform other asset classes over the longer term but in the shorter term they could underperform due to volatility. Buying a high beta stock when you have a low risk appetite is a classic blunder. Similarly, buying a stock hoping that it will give you returns in the next 1 year can also leave you disappointed.

Trying to time the market to catch the highs and lows

When you are investing don’t try to time the market. Buying at the bottom and selling at the top looks quite classy but it rarely happens in the real world. There are two problems with timing the market. Firstly, even the best of traders are not able to consistently catch the lows and the highs of the market. Secondly, the incremental benefit you gain by timing the market is almost negligible. In fact, by trying to time the market you end up overtrading and increasing your cost as well as losing opportunities.

Focusing too much on the past while investing

There is a joke in Wall Street that if investing was all about the past then historians and archaeologists would be the most successful investors in the world. Investing is all about the future and that is what you need to focus on. At best, the past can be a guide to your investments but you cannot predicate your investment decisions purely based on what has already happened. This logic also applies to your investment performance. Don’t focus on the performance of the past. Learn from your mistakes and just move on.

Diversifying without reference to correlations

While creating your portfolio, you need to spread your risk across sectors, across themes and even across asset classes. Putting all your eggs in one basket has never been a good idea. It, perhaps, never will be! But then how to invest in share market that your portfolio is diversified? The answer is to buy assets with low correlation. For example, if you own a banking stock and add an NBFC stock to your portfolio, then you are not diversifying because both the stocks are rate sensitive.

Not reviewing your portfolio regularly

It is not just enough to create a portfolio but you also need to regularly review the portfolio. Review your portfolio based on changing equity valuations, shifting macros, changing interest rates etc. Apart from the external review, also review the investments internally with reference to your return expectations, your long term goals and your risk appetite.

Avoiding these mistakes may not make you a millionaire. At least, it will give you a better investment experience.