Investing in the stock market is an endeavour that promises potential rewards, but is also fraught with risks. Every investor, regardless of their investment experience, can fall prey to common errors that can derail their financial goals. Broadly, these errors can be categorised into two types: Type 1 errors, where an investor selects an inappropriate stock and incur financial losses, and Type 2 errors, where an investor misses out on a lucrative opportunity.

Poor stock choices

Selecting the wrong stock can have dire financial consequences. This error often occurs when investors are swayed by a company’s brand image, market noise or emotional biases rather than focusing on fundamental analysis.

A prominent example of this is the downfall of Kingfisher Airlines. Founded by Vijay Mallya in 2005, Kingfisher Airlines quickly gained popularity for its premium service and its stock prices skyrocketed due to market noise, thereby neglecting due diligence. However, aggressive expansion and mounting debt soon led to financial disaster and by 2011, the airline was struggling with massive debts and operational issues, leading to the suspension of its license in 2012. The company ultimately declared bankruptcy, and Mallya fled to the U.K. to evade legal charges in India. Punj Lloyd, a construction and engineering firm, faced a similar fate. The company accumulated substantial debt due to project delays, cost overruns, and payment issues with clients. Unable to service its debt, Punj Lloyd entered insolvency proceedings in 2018 under the Insolvency and Bankruptcy Code (IBC). These cases underscore the critical importance of thorough research into a company’s financial health, as neglecting this can result in Type 1 errors, where investors select inappropriate stocks and incur financial losses.

Missed opportunities

While missing out on a good stock does not directly impact an investor’s finances, it represents a lost opportunity for potential gains.

However, this is quite acceptable as the investor remains in the investment race, having not lost any capital. During the pandemic, the stock market experienced significant volatility, presenting both risks and opportunities for investors.

One notable example is Tata Motors, whose stock price plummeted to as low as ₹75 in the early days of the pandemic. Investors who recognised the company’s potential and invested at that time have seen substantial returns, as the stock has since soared to a 52-week high of ₹1,065, making it a multibagger investment. Similarly, ITC’s stock was trading at ₹165 during the same period of market uncertainty. Investors who seized this opportunity and invested in ITC have been rewarded handsomely, with the stock reaching a record high of ₹499.70.

While investors who did not invest in Tata Motors or ITC during the pandemic may regret the missed potential for substantial profits, their capital remains intact.

Even the most experienced investors, including Warren Buffett, have made these errors. Buffett has been vocal about the risks associated with airline stocks for over 25 years. In his 1992 shareholder letter, Buffett stated, “Investors have poured money into a bottomless pit, attracted by growth when they should have been repelled by it.”

Despite Buffett’s typical negative stance on airline stocks, Berkshire Hathaway, acquired significant stakes in Delta Air Lines, United Airlines, American Airlines, and Southwest Airlines, spending around $7-8 billion. However, when the pandemic hit and airline stocks plummeted, Buffett quickly exited these positions, incurring losses.

Buffett has also admitted for missing opportunities in the tech sector. At Berkshire Hathaway’s annual meeting in 2017, he acknowledged his mistake for not recognising Google’s potential despite being a customer of its ad business. Historically, Buffett avoided tech stocks as he considered them beyond his circle of competence. He also admitted to underestimating Amazon’s Jeff Bezos and the company’s success, acknowledging Bezos as “one of the most remarkable business persons of our age.”

These examples serve as a reminder that even the most successful investors can make mistakes. Therefore, it is very crucial to heed George Soros’ advice: “It’s not whether you’re right or wrong that’s important, but how much money you make when you’re right and how much you lose when you’re wrong.”

To mitigate these risks, investors should diversify their portfolios rather than betting large capital on a single stock. To make this very simple, we need to just follow Buffet’s two basic rules for investment. Rule 1– Never Lose Capital, Rule 2 – Never forget Rule 1.

(Anand Srinivasan is a Consultant, Sashwath Swaminathan is Research Assistant at Aionion Investment Services)