Young Investor

Common investment mistakes you can avoid

P. Saravanan N. Sivasankaran | Updated on July 02, 2011

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Retail interest in the investment domain, especially in the stock market, has improved multi-fold over the past decade, thanks to rapid advances in technology and amendments in rules and regulations. Now, an individual investor can own, buy or sell even one share. But even as the interest to invest in stock markets has gone up, the level of awareness hasn't improved as much.

Common investing mistakes

Poor understanding of risk and return: What return can one expect from a specific share and what is the risk associated with the same? This question needs to be understood clearly before investing. Expecting a return of 25-30 per cent without risk or doubling money in a year are quite unrealistic in the normal course of business!

Vaguely conceived investment policy: There is a strong relationship between one's risk appetite and where one invests his money. An ambiguously conceived investment policy impairs proper investment decisions. Switching the position from aggressive to conservative and vice versa according to the prevalent market is the most dangerous tactic.

Extrapolation of past trends: Investors by and large extrapolate past trends. Alhough it is a good idea, they tend to forget to incorporate the appropriate changes into their projections. While making the projections one needs to keep in mind the prevailing momentum.

Casual decision making: Frequently, investors' decision making processes are cursory. For instance, they tend to base their decisions on tips and fads instead of quantified risk-return approach. When greed becomes overpowering, they tend to forget the basic elements of risk and wind up following others owing to the temptation to ride the bandwagon.

They also tend to enter after the market after it has advanced for a long time and similarly make untimely exits when the market has been stagnant for a long period, just before it starts going up.

Proper diversification: Many investors have portfolios consisting of sixty to hundred or even more shares of different companies. It is a mammoth task to manage such an overly diversified portfolio! Some investors go to the other extreme and haveunder-diversified portfolios. In both cases they fail to understand the basic philosophy of diversification, which leads to risk reduction.

Wrong perception about profits and losses: Most of the investors are further averse to admitting mistakes. When prices decline, they hope that the price will rebound , regardless of outlook of sector or company. On the contrary, if the price recovers owing to favourable scenario, there is a tendency to sell the stocks when its prices touch their purchase price, even though there is good scope for further increases. So, most investors do the exact opposite of what would have earned them good returns.

So, what are the ways out?

Contrary Thinking: One way to avoid these pitfalls is to not be influenced by mob mentality. Following the crowd often produces poor investment results. Investors must initiate the habit of contrary thinking. However, it does not mean that one should always go against the current market sentiment. Doing so can make you miss out the many opportunities of the market swings. You should instead develop the habit of contrary thinking by means of disciplined buying and selling by specifying the target prices. Another way to do it is to stop tracking the prices of your stocks by the ticker. What matters most is that you buy at a price which will ensure profit and sell at a price where you realise the expected profit.

Patience and perseverance: Patience is a rare characteristic amongst the investors, especially within the younger group. The game of investment requires patience, perseverance and diligence. In the short run, luck may play a role owing to the randomness in the stock price behaviour but in the long run, remember that the random movements tend to even out.

Contentment: It is an important virtue for a prudent and successful investor. Though the advice sounds simple, it is quite difficult to practice. One way to imbibe this virtue is to rely harder on numbers and less on judgement. This was followed by Benjamin Graham too, who is better known as the Father of Security Analysis.

Resilience and openness: Change is certain in the world of investments. For instance, macroeconomic conditions change, new technologies and industries might emerge, consumers' tastes and preference may shift and so on. But investors adjust to these changes poorly. Investors tend to develop a kind of ‘defensive' interpretations of newer developments and that affects their capacity to make good judgments about the future. Hence, having an open mind is crucial for success investing.

Assertiveness: Often investors need to take a call with imperfect information, ambiguous signals and inadequate premises. To succeed in the investment game, an investor should be assertive. Delays may cause one to miss out on valuable opportunities and forego the gains too. Doubtful and half-hearted commitments often lead to dry investment results.

The game of investment like any other requires certain qualities and characteristics on the part of the investors to be successful in the long run. While developing these qualities doesn't promise you superior returns, it does improve your chances of reaping them.

(The authors teach accounting and finance in Indian Institute of Management, Shillong.)

Published on July 02, 2011

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