Nowadays with the advent of availability of information and resources, Investment has become an easier job, one can now invest just by a click of a mouse or even through a mobile application but due to this power bestowed upon an investor he has now become prone to mistakes while investing.
In this article, we will try to understand 6 common mistakes that an investor should avoid –
1. Overspending and under-saving
One of the basic understandings of the relation of savings and expenditure is explained by the equation Savings = Income – Expenditure. It reflects in our investment behavior as well since our earnings are fixed and we keep on continue spending our money on both necessary expenditures as well as unnecessary (discretionary) expenditures.
A common tendency is to spend first and save whatever is left but in order to create long term wealth and ensure that the future is secure one has to understand the equation in a different way i.e. Income – Savings = Expenditure
which implies that we should save first rather invest and a considerable amount of our income towards our future goals and then spend whatever is left out of it. It gives control over spending and a discipline on savings.
2. Not investing for goals
A key approach to investment is deciding the goals, prioritizing the goals depending on the various life cycle stages and assigning monetary values to these goals, and investing accordingly to achieve the goals. These goals could be short terms such as planning for contingency or medium-term such as buying a car or going for a vacation or long-term such as retirement planning.
The biggest advantage of the Goals-based approach provides an investor with clarity regarding the overall structure of investment and portfolio as well it inculcates a discipline amongst the investor who would stick to their goal sticking to the process of portfolio creation and be invested across various investors life cycle.
3. Not understanding the risk
It is very easy to invest without understanding the risks especially when markets are moving upwards and general sentiments are positive, investors often get carried away and ignore the risks.
One has to understand that every investment has a certain degree of risk associated with it and as an investor one has to be aware of the risks and be prepared for the volatility of the portfolio by virtue of those risks.
For example, there is a myth that debt investments are safe (since these investments are in bond) but that is not the case there has to be enough incidence in the history of investment when debt investment has given negative return in 3-6 month horizon and underperformed as compared to even fixed deposits.
The yellow-colored in the picture shows the negative performance which is clearly visible over a period of 3 to 6 months even up to 1 year and the blue color depicts the low return up to a period of 2 or 3 years.
4. Picking investment on past returns and star ratings
A lot of investors do this mistake of relying too much on past returns and picking funds on the basis of past performance, the point to note here is past performance is not a guarantee of the same or similar future returns.
Yes, good past returns show the consistency of performance but the market scenarios, the state of the economy, the Geopolitical situation, the global market, companies’ financial position keep on changing, and since investments are so dynamic one can’t solely rely on past performance.
Also, there are various websites and research articles providing the star ratings to the funds and each has its own method to do so but most of them give huge importance to past returns hence deciding only on basis of star ratings might not be a prudent approach.
5. Ignoring costs
Every investment comes with a cost. Due to the lack of transparency and the practices among the distributors and various intermediaries, most of the investors are not aware of the costs involved in the investments that they do.
As an investor one has to be mindful as the difference between regular (with commission) and direct (without commission) could be from 0.40% to as high as 1.5% and such a difference over a long period due to compounding could eventually prove to be a massive amount.
The above picture shows that even debt funds have a considerable expense ratio from 1.03% to as high as 1.96% and equity funds are even costlier as depicted in the picture below –
6. Too much attention given to financial media
Nowadays there is too much “advise” available to an investor through different medium be it a newspaper, business television channels, social networking websites, and even WhatsApp which makes the investor exposed to many unwanted news and “tips” whereas investment is more about focus, patience and keeping the basics right.
As an investor one needs to be aware of the difference between what he is told to do and what he needs to do.
There is a lot of clutter in the investment arena especially for first-time investors or investors who are confused in terms of their approach towards investments. As an investor one should avoid these mistakes that usually people regret after some time.