Educating Investors

6 costly investment mistakes that one should avoid5 min read

Long term investor believes in buying and holding a particular stock for the long-term as his way of creating wealth and generate passive income. They do not track the price of the stock but analyze the value of the business. This is commonly known as ‘Value Investing Principle of Investment.’ They believe in the fundamentals of the company, and they analyze by comparing ratios, profitability, growth, customer base, geographical presence, quality of management and sustainability of the company with other peers in the same industry. Here are a few things to keep in mind before starting your career as an investor. There are some Costly Investment Mistakes that a naïve investor should avoid in his preliminary phase of the career. 

  1. Timing the markets 

Investors generally wait for the right time to enter. Well, it is important to enter at the right price, but no investor has been successful in predicting the next move of the market. Incorrect entry and exit are one of the most common but costly mistakes that investors tend to make. Their decision to invest in stocks depends on acquaintances. One should not invest in stocks just because other people around are doing so. Such practices often yield subordinate returns in the long term. Instead of timing the markets, it is essential to invest consistently and regularly by spreading out the investment corpus at various time intervals. This will allow the investor to take advantage of rupee cost averaging and watch the investments grow and compound over time.

2. Use of Margin to create leverage for investment

Let us understand the meaning of leverage using Margin money. Margin is simply a loan extended by the broker that allows the investor to enter larger trades on borrowed funds. Leverage in any business means the use of debt to finance the assets. Essentially, leverage will enable you to pay less than the full price for a trade, giving you the ability to enter more significant positions even with a small amount of capital. Historically, debt has proved to be a way for exponential business growth. However, the ability to repay within time is a crucial factor. With long term investing, the leverage can affect the overall returns of the portfolio drastically and wipe out the capital as well.

3. Investment in penny stocks / small caps stocks

One of the most consistent mistakes that the majority of inexperienced investors tend to make is being attracted towards small caps stocks. The reason for this (ultimately dangerous) attraction always comes down to the potential returns and an opportunity to earn higher returns very quickly. In a single week, the price might jump from INR 2 to INR 20. 

Well, it’s an illusion, make no mistake about it. Not all small-cap stocks give such returns. One of the critical investing principles given out by Peter Lynch – ‘Invest in what you understand.’ This has been emphasized and reiterated by many fundamentally profound investors to date. Warren Buffet said that ‘Risk comes from not knowing what you are doing.’

Well, this has been the case for many penny stocks too. With limited information, restricted market participation and lack of liquidity prove to a costly mistake for the investor.

If you pick the right stock, the returns can be exceedingly vast. As against this, choose the wrong stock can erode your entire capital.

4. Lack of Patience

Investors saved money back in the stock market is arguably the single most effective plan to become wealthy. But investing will not make you rich overnight. Unfortunately, many people have high expectations, and when those are not met, such hope can lead to disappointment and cause them to leave investing altogether. Investing is a slow and consistent process that will help an investor to build sustainable wealth. Mr Warren Buffet became the richest person in the early 50s, i.e. after more than 30 years of investing career and continued to remain in the top 10 billionaires list even today. It is essential to be right in your stock selection but more important to be consistent with your decision making.

5. Over Diversification

It is important to have a strategic asset allocation and focus on the benefits offered by Diversification. Mr Warren Buffet had once said that Diversification is a protection against your ignorance. Diversification has proved to be an important risk management technique to mitigate the idiosyncratic risks from specific investments. However, Diversification comes at a cost as it limits the upside returns of the portfolio as well. If an investor is not careful, Diversification could easily lead to over-diversification, impacting the overall profitability of the portfolio over the long term. Over Diversification would lead to loss-making assets evening out the profit-making investments – resulting in lower returns from the portfolio.

To prevent over-diversification, investors must study the business dynamics, industry insights and business models to understand the specific exposure of each investment. 

6. Psychological barriers / Emotional investment

Greed and Fear are the two emotions that drive the market movement daily. The perception of an investor towards risk changes as per the market volatility. The veteran investor Mr, Warren Buffet has said that “Be Greedy when others are fearful and be fearful when others are greedy.” However, it is better said than done as most of the investors are somewhat cautious in a bear market and over-optimistic when the markets have already outperformed. This defies the Value Investing principle leading to improper entries and exit in the market, increasing the potential losses on the portfolio. For a successful investing career, it is imperative to refrain from the emotional biases for any investment. Psychological barriers create a rather inconsistent and indiscipline investing approach affecting the returns from the portfolio.

Investing is not easy, but if the investor steers clear from any one of these pitfalls, it can make a material difference in the portfolio. Making mistakes is not a problem until one learns from the same. 

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