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Learning From Others’ Mistakes

by Tavaga Invest
Financial mistakes

We don’t have to commit some oft-repeated errors when investing, instead, we can focus on forging our own path

By: Tavaga Research

It is often said that we learn from our mistakes. It helps us when we find the fear of a misstep holding us back from something new. In investing, mistakes often increase our risk of losing money or slowing down our rate of earning. But avoiding calculated risks would mean forgoing possible higher returns on our capital as well.

There is a happy resolution. There are some mistakes that are avoidable, leaving us room to commit our own without regretting them. Let’s look at some of the common mistakes which most investors tend to make.

Acting on hearsay

This could mean word-of-mouth of a colleague, a friend, or even a family member. An investment that might have worked for someone else might not work for us in the same way (returns or needs).

It bodes well for the investor who spends some time researching what to put one’s hard-earned money in, no matter how high one’s discretionary income is. If needed, it is best to turn to advisors to at least get started.

Skimming the prospectus

In case of an investment product which comes with a prospectus (the introductory document with the details of the product), many of us do not spend enough time to read through it. We can miss out on crucial details such as asset diversification/allocation details, holdings patterns,  limitations, inclusions, and exclusions if we skim across this vital document.

Not checking the expense ratio

Applicable to asset funds (mutual funds or MFs, and exchange-traded funds or ETFs), an expense ratio is a percentage of the fund asset value (that we hold) which goes towards administrative, management, and other expenditure. The expense ratio in percentage (annual) tells us how much of our total investment in that instrument will be treated as the cost for investing and not be made available to us.

In the case of MFs, expense ratios are much higher than ETFs

Not calculating risk

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We can best tackle risk in two ways. First, gauge our propensity to take risks, and second, consider the risk-adjusted returns on investment products before choosing. Financial advisors, including robo-advisors, can aid in both.

Equities: Overnight get-rich scheme

Any investment in ETFs and stocks is a long-term move. We cannot invest in a high-risk-high-return product and then pray to multiply our wealth overnight. There will be short-term profits or losses depending upon the market situation, but staying invested with the right products for us is the key.

Performance of Apple Inc. since 1980

Source: Google Finance

Not Diversifying Right

Diversification of assets is a thumb-rule for both the young and old. However, we tend to either over-diversify or not diversify at all. Scattering our money in too many investment products results in minimizing returns possible from an optimum mix of assets. Then there are those of us who park our savings in fixed deposits or real estate and treat them as good investments. This non-diversification increases risk as our wealth creation is dependent on only one kind of asset and its shortcomings.

Performance of Gold and Equity ETF over the years

Source: Google Finance

Not getting the right help

Expert take on our asset allocation and our risk-taking capacity will stand us in good stead for a long time. Most of us scrimp on getting these analyzed by a professional and carry on reinvesting on a trial and error basis.

Investing in regular MFs

In the long run, direct MFs which have lower expense ratios are more profitable than their regular variants, compounding more money for us.

Timing the market

For a novice investor, trying to put in more money when the market is down may not be a sound approach. The market can still dip instead of rising, making us regret our purchase. A staggered approach by way of systematic investment plans is advocated in this case. Hasty changes are best avoided unless they are rooted in sound knowledge and research.

In the same vein, picking a fund based on its past performance is not foolproof either. The approach of the fund manager (in the case of MFs) should dictate our choice and the details of allocation in the prospectus.

Plug and forget

Even when we invest at regular intervals and avoid timing the market, we overlook reviewing our investments or tracking their performance. If we lose track, there is no way to realize if there are any course corrections required and we end up with laggards that drag our wealth creation down. Of course, we should remember that certain assets such as equities require time to multiply our money.

No emergency funds

India, with 400 million millennials and counting, is home to a large young population who are entering their investment lifecycle. A novice mistake that can be costly is not leaving enough liquid cash for emergency needs in the zeal to invest. If we end up investing all our savings, a loss of employment or a medical emergency would need money on hand. The most liquid of investments can take one to three business days to be encashed, while illiquid investments like real estate can take many months to encash.

While equities may be easily liquidated, encashing an equity portfolio for immediate needs is clearly a suboptimal strategy as the investment in equities is designed for long-term performance. It is best to leave six months’ worth of living expenditure in one’s savings account before routing disposable income into investments.

Ignoring tax on withdrawals

The earnings from investments are subject to taxation. When withdrawing to reinvest or consume, we need to factor in which tax is applicable as it would erode our take-home returns.

Without a nominee

Our investments should have nominations. If we are now increasingly aware of the need for life insurance, we must also take the task of appointing nominees for investments with equal importance. The money we put in and the wealth we create should not be left to be retrieved in a circuitous manner by our families in case of our premature demise. Nominations help a smoother handover.

Investing is not a stop-gap solution to our financial needs. It calls for a planned and rational approach. It can not be absolutely risk-free. That does not mean we freeze with the fear of losing. Keeping the common mistakes in mind will prevent us from reinventing the wheel with our every choice.

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