Saturday, February 9, 2008

5 Common Investment Mistakes

If you are an investor who believes that getting invested is a simple 3-step process i.e. getting hold of an investment agent, filling up an application form and signing a cheque; then you got it all wrong. Investing is a lot more 'sophisticated' than that. It is an important activity that involves systematically short-listing your most important investment objectives and preparing an investment plan to realise them in the best possible manner. Although this may sound a little difficult, it can be achieved simply by avoiding some very common investment mistakes. Investors must note that since the list of mistakes one must avoid is endless; we have highlighted the five most common mistakes.

1. Investing without a planThe first and most critical step while investing is to outline your
investment objectives. Setting an investment objective simply means prioritising your needs into short, medium and long-term investment goals. For instance, planning for vacation (short-term), planning to buy property (medium to long-term), planning for retirement (long-term). Often investors stumble at the starting point while defining investment objectives; this in turn gets their financial plan in a tizzy.

2. Not diversifying well enough
Diversification is one of the basic tenets of investing. At Personalfn, we regularly meet clients who have invested a large portion of their monies in a single asset (like real estate for instance) or a single investment (like a stock). While such investors may do well during a runup in that asset/market (like real estate or stocks), it takes a downturn to underline how important it is to spread your eggs in more than one basket. Investors, depending on their risk profile should diversify their portfolios across asset classes like equities, fixed income, gold and real estate, among others. Similarly, within an asset class, they should diversify across various avenues, for instance within fixed income they should invest in fixed deposits, fixed maturity plans and small savings schemes. More than anything else, diversification helps to minimise/spread risk particularly during a downturn, as one investment can be a backup for another

3. Ignoring risk
Often investors select an investment avenue/scheme simply because it provides better returns or is recommended by a friend, family member or investment advisor. Investment decisions should not be influenced merely on the basis of performance or a strong recommendation. Investors should understand that various investments have varying risk profiles. For instance, stocks/equity funds have a higher risk profile, while debt is relatively low risk. You must select an investment based on whether it suits your risk profile. For instance, a 55-Yr old who is headed for retirement must avoid technology stocks, which can prove apt for a 30-Yr old.

4. Getting married to your investments
Often investors have 'pet' investments and they can get attached to the same. So despite a dismal show, some 'pet' investments manage to hold their ground in the portfolio. Getting attached to your investments can prove detrimental to your investment plan. Is that house/car/vacation more important or a non-performing investment? The answer is obvious to any rational investor. Ensure that you review your portfolio regularly and weed out the duds. If an investment is no longer contributing to your investment objective, it has no business being in your portfolio

5. Timing the markets
Some investors often delude themselves into believing that they are experts. So more than investing, they are often engaged in 'pastimes' like timing the markets. To be sure, even when market-timing works (which is rare since no one can predict stock market movements accurately and consistently), it does not do significantly better than regular investing regardless of market movements. Studies have shown that even if an investor called the market bottom consistently and accurately over a period of time, he would have done only slightly better than the investor who invests (the same amount) regularly over the same time period. This is no magic; this is the result of cost averaging and compounding (which incidentally Albert Einstein called 'the greatest mathematical discovery of all time').

Put simply, this implies that risk-taking investors must abandon the temptation to get caught up with stock market highs and lows. Instead, they must work at regularly setting aside a sum of money and investing the same in line with their risk profiles regardless of stock market fluctuations