Each person to has ever invested in the stock market will tell you they have made mistakes. They will sigh about the missed opportunities and untimely misjudgments. To have skin in the game, they say, you must have thick skin.
Risk is something you sign up for when you invest in the stock market – but you must, at all times, try to minimize it. It pays to remember the basics to avoid grave mistakes that might cost you a fortune.
Here are some common financial mistakes that investors are often guilty of and how to avoid them:
1. Not Paying Attention to the Market
Markets change by the second. At any point in time, several factors come into play that could change the way the market or a segment of the market behaves. Anything and everything can affect an asset’s price, and it is important to know the difference between short-term events and those that are medium to long-term.
For instance, a celebrity snubbing a product at a public event may have a short-term influence on the market and must not be mistaken otherwise. Therefore, it pays to invest your time in the market before you invest your money.
How to Avoid This Mistake
Be on the lookout for business news via newspapers or relevant apps on your phone. No, you don’t need to be a know-it-all, but being attentive enough to know things that matter goes a long way.
2. Timing It Wrong
Investments are equally about ‘what’ and ‘when’. While it is not advisable to try to time the market, it is important to make timely decisions to reap profits from your investments. For instance, waiting too long for a loss-making asset to do better can be counterproductive.
Another timing issue involves investing when the market is already in the bull run. Sanjay Dongre, UTI AMC, cautions investors to be careful while investing during the pandemic and recommends giving preference to Systematic Investment Plans (SIPs) to fight market volatility.
How to Avoid This Mistake
Don’t be greedy! When you hit your targeted profit rate, make sure to sell. When the market is down, make sure to buy but in moderation at a time. Be extra cautious when investing in a saturated market. While these rules are not set in stone, they are generally what seasoned investors swear by.
3. Lack of Knowledge
Often, people invest in a company without knowing its background, financial positions, and future prospects. It is also common to mistake the past profit-making trend of the company for a future promise.
If an asset is performing well, it is possible that its market is already saturated, and your investments would not be as fruitful as you might imagine. Warren Buffett’s investment philosophy is to determine which companies are undervalued and therefore provide potential to earn profits as an investor.
How to Avoid This Mistake
Do not invest without digging deep into the books of the companies you want to invest in. Thorough research will ensure that you only invest in assets that align with your personal goals. It is better yet to invest in a basket of equities rather than in a single company, which helps diversify risk.
4. Poor Diversification
Diversification protects your investments against market volatility by balancing out risky holdings with stable assets. Diversification is seemingly an easy task, but it involves detailed subject knowledge about different kinds of assets and the risks involved in them.
For instance, for a low to moderate risk-friendly individual, a thumb rule to follow for asset allocation is to subtract your age from 100, and the number you get is what you should invest in stocks. This means that if you are 30 years old, about 70% of your wealth should be in the form of equity.
As tempting as it seems, it is never a good idea to put all your eggs in one basket. You should also be mindful not to over-diversify; a study quoted by Forbes states that the benefits of diversifying disappear in the range of 20 to 30 securities.
How to Avoid This Mistake
Make sure you spread your investments across different sectors, and even for different time periods (short/medium/long term). For mutual funds, diversify between small/mid and large-cap funds keeping in mind your risk appetite. While small or mid-cap funds provide better returns, they are riskier than the more stable large-cap funds.
It is best to build your portfolio with the help of a financial analyst who can extend their expertise to ensure the best possible outcome for you. Checking your portfolio health is one of the most important steps towards a stable, profitable future.
5. Basing Decisions on Emotions
It is only human to be driven by emotions rather than logic from time to time. Business spirits, as they say, rule the market. Market crashes are caused by panicky investors driven by fear. Market bubbles, on the other hand, are caused by investors’ greed.
Emotions also play a role when you invest in only those companies that you know about. Having unrealistic expectations from the market is another mistake that is common to many.
How to Avoid This Mistake
The best strategy to avoid emotions is to make the best investment plan and stick to it. Let your decisions be based on logic and research. Even though short-term fluctuations are common, it is important to remember that it is the patient investors that gain the most out of the emotional decisions of others.
The Bottom Line
Mistakes are a part of the stock market, and you will inevitably make some. But if you do remember these common mistakes, chances are you will avoid most of them. Decide your appetite for risk, develop a strategic and systematic plan, and start investing accordingly.
Seasoned investors will tell you that they often look at the bigger picture and invest for the long term. However, they also put aside some ‘fun’ money they are ready to lose on risky assets. A balanced portfolio goes a long way.
