As discussed in Part 1 of this series, I will be covering common investment mistakes made during different stages of the investment journey. I have divided the investment planning journey into three different stages:
- Initial Stage (Before Investing) – where you have not yet started any investment process.
- Second Stage (While Investing) – where you decide and select suitable investments in order to build a solid portfolio.
- Final Stage (After Investing) – where you have built your portfolio and are looking forward to financial freedom.
In this post lets talk about the next stage of investment journey.
Stage 2 – While Investing
If the first stage can be called the the thinking stage, this second stage should be the doing stage. While mistakes in the first stage are more psychological in nature, the mistakes in this stage are more practical nature.
Lets find out what these avoidable mistakes are:
- Confusing insurance for investment
This is the most common but critical mistake made by many. People (either due to ignorance or due to some other misplaced notions) opt for endowment or money back life insurance plans and assume that they have taken care of their insurance and investment needs. But in reality by opting for such insurance schemes you end up failing in the purpose of both. Keep both insurance and investment separate and plan for them accordingly. I have written about it in detail in an earlier post.
- Absence of an investment plan
Many people select their investments in an ad hoc manner. This is the biggest mistake they can make, because this means that their investments are direction-less. Always have a written investment plan in place which should cover the following aspects:
1) What your short term and long term investment goals are
2) How much money you can invest and for how long
3) What’s your risk appetite
After considering all these aspects, select suitable investment products and build a solid portfolio which will help you in achieving your goals. Remember, investment is a means to an end and not an end itself. You are investing to achieve *something* in the future (house or car maybe), not for the sake of investing. Therefore is important that you should have an investment plan in place.
- Poor Diversification
Diversification is an important strategy & risk management tool which needs to be implemented properly. But this doesn’t mean that you should start investing in anything and everything. More is not always better. Investing in many mutual funds will not make your portfolio diverse if they all comprise of the same kind of instruments – investing in 5 different large-cap equity funds is NOT diversification. This will result in duplication instead of a diversification. To gain proper diversification, invest in different asset classes, segments, sectors etc, in other words invest in different sources of returns. As a rule of thumb do not invest more than 25% in one sector – like if you invest 40% in the financial sector & a banking downturn occurs you’ll be out of a lot of money.
- Chasing the returns
This is another increasingly common but critical mistake. What people do is ask and search “What are the best performing mutual funds or stocks to invest in?” (read highest returns) and invest in them blindly. This is the worst thing to do, because this question is incomplete in nature – which automatically means that any answer to the above question will not be valid. The complete and correct question will be “What are the best performing mutual funds or stocks to invest in for me?” These last two words are very important because this covers your requirements like risk appetite, time horizon etc.
Say you find that a particular small cap equity mutual fund was the best performing fund last year and you invest a major portion of your investment in it in the hope of gaining highest returns. But this was a high-risk fund & you don’t like taking a lot of risk! Ouch.
Also, the basic fact is that past returns are no indicator or guarantee of future performance. Therefore, instead of focusing all your attention on chasing after returns, spend time and understand your situation and goals, and then select the suitable product,after conducting a thorough research and understanding the risk/return dynamics of the product
- Taking advice from unreliable sources
You will get investment advice from many different sources – be it your family members, friends, colleagues, etc. They will try and convince you into investing in the next big thing or offer you a great tip on making more money, but remember that this advice is more or less speculative and biased in nature. Never act on those suggestions. It will do more harm than good. Always make sure that the person you turn to for advice has your best interest at heart along with impeccable credentials and a designation like CFA or CFP.
- Investing all at once
Never ever invest big lump sum amounts in a single day. This can increase your chances of failing victim to market cycles. Instead spread your investments systematically, this will help in reducing the risk factor and make volatility of the market work for you. If you are a salaried person opt for Systematic Investment Plans. If you are self employed or a freelancer go for Systematic Transfer Plans.