What’s common between Usain Bolt, Michael Jordan, and a good investor? They never make the same mistake twice. They never miss an opportunity to learn from the mistakes of others. As a result, they’re successful in their respective disciplines.
Just like sports, success from investing in the stock market and mutual funds requires time, discipline, patience, research, and expert guidance.
You may have heard of people often complaining about the stock market being a tough place to make money consistently or blaming it for their huge losses. However, we also hear success stories of investors making enormous profits.
How can one explain such completely different experiences in the stock market? Many things for sure. But it is safe to say that successful ones made fewer mistakes and learnt from the mistakes other investors make. How can you do the same?
No matter whether you are a beginner investing in stock markets or a seasoned pro, you cannot avoid making mistakes. And yes, you can and must learn from these mistakes. But for some investing mistakes involving considerably high stakes, it is best to pay heed to what Otto von Bismarck said
“Only a fool learns from his own mistakes. The wise man learns from the mistakes of others.”
You wouldn’t risk not wearing protective gear while mounting a sports bike, would you?
We’ve identified the top 7 frequently committed mistakes so that you are better informed and can avoid them during your next investment.
Let’s dive in.
Thinking of Investing as a Sprint when it is a Marathon
When you are investing, you are bound to experience a whirlwind of emotions, but impatience is among the costliest of them all.
Budding investors think of investing as a sprint, chasing high returns to make a quick buck rather than a marathon which it is since investing is done to meet financial goals that are in the future, sometimes a couple of decades. A Marathon requires keeping a steady pace to complete the race and investing requires consistent returns. But investors are impatient and chase returns. This is one of the biggest investment mistakes. A “high-returns” way of investing means taking high risks and exposing yourself to large volatility. When that happens, retail investors usually quit, many a time incurring real losses.
You need to understand that you are investing in shares of real-world business, and as much as you hope and pray, businesses actually grow quite slowly compared to your expectations. However, when they grow consistently year after year, their profits compound and become very large. And their stock price growth eventually reflects this.
As Benjamin Graham – the guru of investing said:
“In the short run, a market is a voting machine but in the long run, it is a weighing machine.”
In the short term, prices fluctuate because of the demand and supply of shares and this is largely driven by speculation. However, in the long term, the market reflects the true worth of the stock which depends on the company’s performance. Therefore it will take time for a good investment to grow into something substantial, but it does with the power of compounding as long as you stay invested. Just like a marathon, staying in the race means keeping a steady pace, and eventually, you do cover the distance while those who try run very fast seldom do.
Read more about the formula for growing wealth and what it tells us about investing, here.
The biggest reason for failure in investing is an under-estimating risk while chasing quick and high returns. Most investors take high risks many times without knowing it. While the risk is real, though sometimes it does not always materialize (thank God!), high returns are not guaranteed.
Portfolios of investors with unreal expectations chasing quick high returns will be loaded with stocks that are small and micro-cap or those bought at very high prices expecting it to rise further.
Such a portfolio may move up for some time but will move down substantially and faster than you can act.
For example when a stock-specific event occurs (which is not uncommon in small and micro-cap stocks and even happens in even large and mid-cap stocks every once in a while).
Prices fall hard and very rapidly (eg. 50%).
Investors will freeze and will not act and as a result, get completely wiped out.
Why did this happen?
Because their expectations of earning very high returns made them susceptible to taking on very high risks. Sooner or later, some of this risk materializes and they realize that they are not up to handle it.
So how does one avoid making this mistake? Keep returns expectations reasonable, say twice the returns ( i.e., 12% – 15%) that you would get from an FD, but consistently. This will make good quality stocks attractive to invest in while you avoid speculative ones. And you may be surprised by better than expected returns but it’s best to attribute it to good luck. Planning for anything more tends to increase the probability of disappointment.
Read more about the consequences of very high expectations while investing, here.
If you aren’t planning an investment without sufficient diversification, you might as well walk into a casino and hope to win the jackpot.
Placing all your bets on one or very few companies is a recipe for disaster.
What if it goes bankrupt?
What if there is a massive management shakeup?
A lawsuit blindsides them and drives it to the ground?
What if that particular industry faces a huge challenge?
Not to mention waking up every morning with palpitations and refreshing your stock market ticker and praying you to see green!
Specific stock prices can be volatile and there can be extreme movements at times. Having a portfolio of very few stocks means your investment will fluctuate with the stock.
Diversification ensures you make multiple investments across industries which saves you from a major loss if one of the stocks loses money or if one industry is in turmoil.
So, how much is just right?
Usually, 18 to 25 stocks provide good diversification. So, even if a few of these drops sharply your total investment will not because chances are that some of the stocks in your portfolio may rise to reduce the loss or showing an overall gain.
Read more about how to build a stock portfolio to meet your financial goals?, here.
Investing Money You Cannot Afford to Risk
If you put money that you will require after a short period of time in equity, you are actually not investing and more importantly, are running a big risk.
What if the market is down when you urgently require money? You will naturally be forced to sell at low prices either incurring a loss or earning less than FD returns.
Putting money in equity for the short term is not investing.
It is trading…
It is mere speculation…
You will experience high emotions and stress levels, and consequently, make wrong decisions.
It is recommended that you only invest money that you don’t need for the next 5+ years in equity, allowing your investments to grow and compound. You should be able to ride through any downturn in the market that could last for a few months even a few years.
Not Investing in Your Financial Education
It is said that a little knowledge is always dangerous and this is true about investing. Many retail investors start investing with the little knowledge that they may have learnt through friends, relatives, or the media. This is far from sufficient.
It can be thrilling to see the stock graphs move up and beginner investors often tend to invest more thinking they really understand these things and it’s okay to take risks. But markets will go through cycles and corrections are steep and fast especially for mid and small cap stocks. When such corrections happen, such retail investors go through the stages of denial (it’s only temporary, it will go up again), fear and panic before selling at the near bottom which goes against the very philosophy of investing.
Going into investing not knowing how mutual funds and stocks make money is the same as digging up a random plot of land and hoping that there’s gold underneath.
Knowledge can help you distinguish the good advice from not so good and bad advice. It can help you differentiate between a good stock and a bad stock.
Take some time out to understand the fundamentals of investing, understand how to assess a company and stock, how to build a strong portfolio, how mutual funds make money, the basics and you will not only avoid common investing mistakes mentioned in this article but slowly but surely take better investment decisions.
Our knowledge base “Investment Shastra” covers a number of aspects along with tools to help you better understand the fundamentals of investing and assist you in making better-informed decisions.
Discipline and diversification are two secrets to great investment decisions. What’s more. They don’t cost a single rupee! And it’s up to us as rational investors to leverage them to create wealth.
It is important to invest a certain amount of time, besides your money to have a clear vision and understand how investing can help you achieve your financial goals.
Investing is a long journey, usually over decades if you are young. And the key to building wealth is letting the power of compounding works its magic for you. And that means investing in a way that makes it easy for you to stay invested for as long as it takes.
And the key to good returns is
- Invest money in equity only that you don’t need to touch for at least 5+ years
- Have reasonable returns expectations
- Ensure optimal diversification
- Have a basic understanding of the fundamentals of investing
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