- When investing, the stakes are high: any major mistake will lead to significant loss of money!
- Increase your chances of investment success by avoiding common mistakes.
"I made a killing on Wall Street a few years ago...I shot my broker"- Groucho Marx
Are you new to investing? Do you feel that investing in stocks is similar to gambling?
A successful investor does the basics right and avoids certain common mistakes. Avoiding these mistakes would improve the chances of achieving your financial/investment goals.
1. Start Investing Early
Albert Einstein called "compound interest the greatest mathematical invention of all time". In fact, "the time value of money" is the very first chapter for investment professionals. If time is money, it is probably because of this principle.
Consider you and your friend. Your friend started investing at the age of 25. She invested $100 every month at an interest rate of 12% p.a. By the time she attains the age of 60, she would have made more than half a million dollars. Whereas you started investing at the age of 35. Other factors remaining same, you would have made only ~$200,000. The earnings curve is as described in the chart. Hence, the moral of the story is “Start Investing Early”.
2. Be an investor, not a speculator
For investors, it’s all about time in the market (number of days a particular stock is held) and not timing the market. Investors don’t go by hot rumors about a company or just because their friend thought it is a great investment. They do invest only after analyzing the stock (company) and checking it with their financial adviser. But once invested, they stay till the time the stock remains an attractive investment. Another hallmark of an investor is patience.
3. Seek Advice from Professional Investment Advisers
To a beginner, the stock market can appear daunting. Of late stock market collapses have done very little to dispel the fears that investing in stock market is a risky proposition. There are certified financial advisers available across all major towns and cities who would be willing to help you with your investments. Typically, all brokers have their own advisory services available which you can subscribe to. In case, you feel that the paid means are expensive, and want to do it yourself, sites like ours provide good investment ideas. Also, it is important to note that the frequent entry and exit from your portfolio holdings would increase the commission charges, thereby reducing your returns significantly.
4. Buy a company, not its emotions (familiarity bias)
Emotional investors buy a stock relying on stories rather than detailed financial analysis. As a result of this, they end up over-estimating the price movement in the near future and end up taking excessive risks. Think of it this way. Would you lend to someone just because someone is so popular without a good net worth.
5. Don't join the herd while making investment decisions
Many new investors select their stock portfolio solely based on recent returns. Just try applying a counter thought, now since the stock has already hit its peak for the past many days, isn’t it time for a price correction of the stock based on its actual intrinsic value? This counter thought would prevent you from taking ‘excessive risk’ and from buying the ‘market emotion’ into your portfolio.
6. Understanding your risk appetite
Imagine you had invested $100,000 in 2008, when the market was at its peak and in 2009 recession, your portfolio had lost more than 50% with a closing net-worth of $50,000. Would you have the risk appetite to bear it? We advise young/new investors to start investing only after all their basic financial needs are met. The checklist includes: 3 months of your monthly earnings in a bank’s savings account is considered as a must; 12 months of your salary in a safe option like government or municipal bonds; and an appropriate pension scheme (401K) to suit your lifestyle post retirement.
Young investors have an advantage due to their age and ability to take risk. Starting to invest at an early age could lead to a bigger and better portfolio tomorrow.
7. Diversify your investment portfolio
Simple rule states that “Do not put all your eggs in one basket”. Diversifying your portfolio of stocks helps negate the risk of churning negative returns (especially during recession). Investing in Index Funds or mutual funds eliminates the risk that a typical stock portfolio possess.
8. Taking debt for investing
Yes! We did say young investors have a better appetite to take additional risk, but definitely not using borrowed funds. Here is a case where let’s assume you borrowed funds at for a short-term at an interest rate of 5% and invested $10,000, and then make a loss of 15% ($8,500). So your net loss calculation would work out to be:
Additional Interest Expense of $500 and Net Loss of $1,500; Sum of both = $2,000…Against an investment of $10,000 fetching a negative return of -20%. “To invest with funds borrowed through credit card is disastrous !”
9. Be an active investor
Many new investors indulge in investing with a lot of enthusiasm, but their initial interest fades over time. If you don’t have the time, or conviction, to regularly monitor your investment, rely on financial investment services and advice from professional investment counselors. Different investments grow at a different rate. By re-balancing at least once in six months, you would be able to get away with stocks which have not performed very well and acquire the ones with brighter prospects. This would enhance the overall profitability/returns in your portfolio.
The bottom line is important for any investment. Doesn't matter how much you have invested. A few bottom line principles to be kept in mind are: avoid high fees; diversify your investments; review and make necessary changes to your portfolio in consultation with your investment adviser remembering that stock-market investments are long-term commitments.